Investment Newsletter September 2017
Hubble bubble We have been relatively cautious about stockmarkets for a while. However, that doesn’t necessarily mean that we are in the midst of a bubble. A bubble is usually defined as a rapid escalation of prices in a particular sector, far in excess of its intrinsic value. It is usually characterised by market “euphoria” where any bad news is ignored and positive data is jumped upon and seen as proof that prices will rise even further.
Mike Deverell Investment Manager
Often with bubbles we hear talk of new “paradigms” and arguments given why different rules apply to that asset class which means that it’s not as expensive as it appears! Whilst we think markets are looking relatively expensive, we don’t see many signs of a classic bubble
in stocks. If we did, we’d be much more cautious than we are now! Our view on markets is fairly simple. When they look cheaper we hold more in equities. As they start to get more expensive we reduce exposure, and we carry on doing that in small stages. At present we hold quite a lot less in equity than we usually do. Chart 1 shows the price/earnings (PE) ratio of the UK stockmarket since the financial crisis (blue line). This ratio simply takes the total value of all stocks in the market and divides it by their total earnings (or profits). The orange line is the FTSE 100 over the same time period (right hand scale).
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire, SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2017
Chart 1
UK market PE
FTSE 100 (RH scale)
Back in 2009 the market was priced at around seven times earnings. By 2011 that had risen to 15 times before dropping back along with the market during the Euro crisis. Since then, the market has generally got more and more expensive. This shows that much of the growth in stocks over that time period has not been because profits have grown, but because investors have been willing to pay a higher
It’s been a while…
It is fair to say it’s been a long time since we have seen a significant fall in markets. Chart 2 shows various bull markets throughout history (looking at the S&P 500, the main US stockmarket). In this instance the definition of a bull markets is the period without a fall of more than 20%. Only the bull market from 1990 to 2000 has had a longer period without a 20% crash.
Source: Thomson Rueters Datastream / Equilibrium Investment Team
multiple of those profits. Right now the market is valued at over 20 times earnings, above the long term average of around 14. In general, as the market has become more expensive we have taken profits as we go along and slowly reduced equity. However, the opposite has also been true. Whenever markets have become cheaper, usually through a short term market dip, we have topped up equities.
Based on this we might be overdue a correction. However, the global economy is growing robustly, even if there are some specific issues in the UK related to falling wages in real terms, as covered in previous newsletters. Therefore, should bull markets drop back we would again use it as an opportunity to buy into stocks.
Chart 2: Longest bull markets since WWII
Source: Yahoo Finance, St Louis Federal Reserve, S&P Capital IQ
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire, SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2017
Toil & trouble
If you want to know what a real bubble looks like, have a look at chart 3. This chart (from the FT) shows the price of Bitcoin against the classic bubble behaviour. In our view Bitcoin is in the classic “euphoria” phase of a bubble, where it receives extensive media coverage explaining how it is going to change the world. So what exactly is Bitcoin? Former governor of the Bank of England Mervyn King recently described it as a “sort of digital gold”. Another way of describing it is as a currency without a country. Money essentially doesn’t have any intrinsic value. It only works as long as we all have the confidence that the pound in our pocket can be exchanged for goods or services. We gain that confidence because the pound is backed by the UK state and the Bank of England, and because 60+ million of us have all agreed to use it! Bitcoin is the same but without a government standing behind it and without the history behind it. That’s not to say there’s anything essentially wrong with the concept, but it’s a lot more risky than buying dollars, euros or even gold.
Bitcoin is digitally traded and anonymous. That makes it useful for those who don’t want their transactions to be traced. For example, many Chinese have used it to circumvent capital controls restricting the amount of currency they can move into and out of the country. In the six months to mid January, Chinese exchanges accounted for 98% of all bitcoin trading according to bitcoinity.org. The Chinese government then increased regulation and that ratio has since fallen to 18%. However, they are rumoured to be about to ban their domestic exchanges and this has already caused a 13% correction in the price of Bitcoin. More recently, North Korea seems to have upped their Bitcoin use as a way to circumvent international sanctions. Any sort of crackdown on this sort of behaviour could see a big drop in the price. Some of the technology behind Bitcoin is very innovative and is eventually likely to become part of the mainstream financial system. However, anyone purchasing Bitcoin now as an investment is taking a massive gamble.
Chart 3: Is Bitcoin heading into classic bubble territory?
$ per Bitcoin
Classic bubble
Source: Thomson Rueters Datastream / Equilibrium Investment Team
Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire, SK9 3ND. Both companies are registered in England and Wales.
Investment Newsletter September 2017
General Economic Overview Recent economic indicators have remained robust in most areas of the globe. However, tensions surrounding North Korea have affected some markets. One of the weakest economies this year has been the UK. Inflation has risen to 2.9% (CPI) this month as the weak pound pushes up the price of imported products and services. Wages are rising slower than inflation and so are falling in real terms. The good news is that inflation may soon peak. It seems unlikely that either the UK or US central banks will increase rates this year, although this will partly depend on the inflation outlook. Asset class key + positive - negative = neutral (normal behaviour)
+5 strongly positive -5 strongly negative
Asset Class
Score
Equity Markets Western stockmarkets such as the UK, US and European markets look quite expensive in our view. However, we do see better value in markets like Asia including Japan. Our score is slightly improved from last month as we have seen more evidence of earnings growth.
-4
Fixed Interest We generally prefer corporate bonds to government bonds and are positioned towards bonds which have low sensitivity to interest rate movements given the potential for higher rates going forward. The score is unchanged over the month.
-4
Commercial Property Returns from commercial property are likely to be low but positive. Rental income will be the main component of returns rather than the capital growth seen in recent years. Brexit raises particular issues for the London office market and we are avoiding this part of the market.
Cash With interest rates remaining at record lows, returns on cash will remain below average for the foreseeable future.
-4 -5
Balanced Asset Allocation For a typical balanced portfolio we are underweight fixed interest and equity, and hold only a small amount of property. This is balanced by additional holdings in defined returns, alternative equity and tactical cash.
A neutral score (=) means we expect the asset class to move in line with our long term assumptions: 10% pa for equity, 7% for property, 6% for fixed interest, 5% for residential property, and 3% for cash. A +5 score means we think the asset class could outperform by 50% or more. A -5% means we think it could underperform by 50%. A negative score does not necessarily mean we think the asset class will fall.
These represent Equilibrium’s collective views. The value of your investments can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested. We usually recommend holding at least some funds in all asset classes at all times and adjust weightings to reflect the above views. These are not personal recommendations so please do not take action without speaking to your adviser. Equilibrium Asset Management LLP (OC316532) and Equilibrium Investment Management LLP (OC390700) are authorised and regulated by the Financial Conduct Authority and are entered on the financial services register under references 452261 and 776977 respectively. Registered Offices: Brooke Court, Lower Meadow Road, Handforth Dean, Wilmslow, Cheshire, SK9 3ND. Both companies are registered in England and Wales.