Investment, Market news | 28 August, 2019

Are we facing the imminent collapse of equities?

Raúl Rendon Portfolio Manager

Equity market analysis and valuations

Equity market valuations are at historically very high levels, which implies that long-term yields for investors will be lower than in the past.

We are actually reading, in websites specialised in financial activity, about the imminent collapse of the equity indices or the divergence between the macroeconomic situation and the U.S. indices, which are close to record highs. I can’t help being struck by the effect on human psychology of people who are being bombarded with information anticipating the arrival of the four horsemen of the apocalypse in the share indices.

In fact, this month marks the fortieth anniversary (13/08/79) of the headline “The death of equities: How inflation is destroying the Stock Market” in a specialist business magazine. It was the prelude to one of the biggest gains in the S&P500; and a magazine specialising in finance used the headline “the death of equities” on the cover of its May 2012 issue, mentioning the end of the love affair with these assets; this was also just before a rally which took the S&P500 from levels of around 1,300 units to the present 2,900.

The most hated rally in history

Continuing with headlines of this type, it is also striking that covers alluding to the fact that this market has been the most hated in history are also spreading. Interestingly, the “most hated” phrase has been repeated in the last decade on “n” number of occasions, reflecting the fact that a  significant number of investors has been out of the market waiting for a correction that will take shares to more comfortable levels for participants. It is not surprising that in corrective processes the “Perma bears” find a space to reaffirm their ideas by feeding the environment of fear and distrust and creating a vicious circle.

“Even a broken watch is correct twice a day”

This is one of the phrases that I like most, given that people who are considered unreliable may occasionally be right by accident; and considering the nature of the economic cycles, ranging between expansive and recessive processes, it is to be expected that at some point the headlines will coincide with a bear market. However, so far – if we can make history as a reference – as an idea becomes a consensus it tends to lose its validity.

What future is there for equities?

This is one of the most frequent questions; not only now, but arising recurrently in the wake of increased volatility. In this respect, is clear that the economic future is NOT predictable; in any event, the power of prediction lies mainly in physical patterns (driving, playing the piano, sports, etc.). Also interesting are the studies published by the Journal of Psychological Science in the field of geopolitical prediction. Although the results are not 100% reliable, the article makes the interesting point that although the prognosis has been approached from a statistical point of view, it can be improved by introducing behavioural influences that allow open-minded thinking to deal with uncertainty, a situation that again brings us to the field of behavioural theory that we discussed in an article a couple of months ago.

What should I do with my investment portfolio?

The environment is still complex. First, we have macro variables that show a clear global slowdown; some companies have adjusted their profit expectations, trade tensions with the US persist, with greater ups and downs (via tweets) than we could have estimated; and then, countercyclical measures have been implemented in the previous months with a cut in interest rates by various central banks around the world, the Fed mentioned in its last meeting that its balance sheet would cease to decline, and comments are beginning to emerge that economies with surpluses (like Germany) could increase government spending to shore up the economy.

To these factors, we should add that various surveys suggest the market as a whole is underweight in equities – who is still there to sell? – and positioning is defensive by nature, so an improvement of the macro-environment could catalyse and increase the cost of a market that, as previously published, has extended valuation metrics.

It is not easy – when is it? – to tie the environment to positioning; in any case, one element that from my point of view is uncomfortable is that bull markets “die” in an environment of euphoria. This situation so far seems absent and leaves us in doubt as to whether we are or are not close to a significant correction.

Our conclusion remains: equity must be aligned with each investor’s profile and risk tolerance. We do not consider that the buy & hold strategy is the most appropriate in this environment; so we continue to opt for a more opportunistic strategy with more limited investment horizons. We again urge you to consult with your financial advisor, who can show you the best products that fit your investment profile in what is a complex environment.

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