Last week’s sell-off in global stockmarkets put an end to a prolonged period of low volatility and gave investors a healthy ‘wake-up’ call to the reality that equities don’t go up forever. We had been reading an increasing number of reports that investor ‘bullishness’ was in a state of permanent euphoria that would lead to a ‘market melt-up’.
Wall Street’s S&P 500 Index of US stocks fell by 10% in total, which meant it was officially called a ‘correction’. As usual, Wall Street’s jitters quickly spread to all other markets including the UK and the FTSE-100 was down by 8%. For the moment, markets have steadied themselves and recovered slightly; rumours abound that the US Treasury Department’s ‘Plunge Protection Team’ were busy buying stocks to stabilise the market.
What caused it?
Inflation fears, fuelled by globally synchronised economic growth, low levels of unemployment, rising wages, US tax cuts and the prospect of the Federal Reserve applying the brakes through monetary tightening were the reasons for slide. Higher Government Bond yields are now on the cards. Bill Gross, the legendary bond investor announced the “end of the Bull Market for bonds” – after 35 years of falling yields US 10-year Treasuries are now leading the charge to 3% – they are currently at 2.8%.
Whilst few people are expecting an immediate 1970’s style inflationary surge and point to continued deflationary pressure from the effects of globalisation and demographic trends in the West, it’s important to place these small increases in inflation and rising bond yields in context. We are coming off a ‘near-zero rate interest policy’ so it won’t take much of a rise to see the effect on the costs of servicing debt, with clear implications that too much tightening would cut liquidity and kill the economy. As Bonds are universally agreed to be highly overvalued, investors are right to be nervous.
Economies continue to grow – but markets have de-coupled
Although we can expect more market volatility in 2018 the data points to the current business cycle continuing for some time yet. There are no signs of recession and recessions don’t come out of nowhere. Economic growth has picked up, some countries are doing very well, we may not be running at pre-2008 levels but that period was unsustainable. Corporate profits are still pretty good; these are all factors that support markets in the short-term. What is clear since the banking crisis of 2008 is that markets don’t necessarily reflect the underlying nature of the economy – they have been too significantly distorted by Central Bank Monetary Policy over the past few years. Therefore, we shouldn’t be too surprised if markets behave irrationally and out of sync with the economy. In other words, I don’t think we need to wait for a recession before we see another market correction.
What we are doing
We are switching out of long-term Gilts and Bonds and increasing our exposure to index-linked and commercial property. We think both asset classes offer a good long-term inflation hedge. We also note that the property funds we use have little or no debt. Furthermore, changes in Permitted Development is seeing a huge increase in the number of commercial properties being converted to residential, so these buildings won’t be left without tenants or owners even if Brexit does its worst. Equities could soon recover their losses and continue their advance, but we will be taking some profits along the way.
For more information please contact us.