I think it is fair to say that in recent weeks we have been pretty much bombarded with negativity. After many years of calling for the end of the world many commentators appeared to get their wish on the 24th of June.
Brexit happened and the Four Horsemen of the Apocalypse had finally arrived to usher in the great bear market that would devastate us all.
However, a curious thing has happened since and very few people seem to be talking about it. The S&P 500 has moved to all-time highs. Hands up who would have expected that in the days after the referendum.
Nevertheless, this does not seem to dent the enthusiasm of the Cassandras amongst us, who declare the market is wrong, that it is artificial, that a collapse is imminent. The internet doesn’t forget though and it is often amusing to google what certain ‘doomsters’ were saying over the past few years. It seems disaster has been around the corner for the entire bull market since March 2009. Perhaps we shouldn’t pay attention to sensationalists.
This is not to say that the referendum result has not introduced additional risk. We think it has and we are monitoring Euro-zone stress indicators. There remains clear economic tension in the Euro-zone, with German policy seemingly intent on rebalancing the Euro-zone economy through policies of labour market reform and restructuring, without sufficient acknowledgement that the European economy needs more growth oriented policies.
Now this may change amidst the growing realisation that moribund economic growth and high unemployment are a breeding ground for populism and more growth oriented policies, alongside the proactive ECB, would be very positive for European assets. However, until we see some evidence of this, the increased political risk post the referendum is a negative for European assets, notwithstanding the fact that European equity markets continue to trade on very undemanding valuations.
However, an appreciation of some increased risk is a million miles away from a negative view and the simple fact is that the world equity market is higher now that it was before the referendum in Euro terms. Despite all the negative news, equity markets are higher.
Now we can hypothesise as to why this is the case in the aftermath of an apparent economic meteoroid but it is simply a fact and we are impressed by the strength of global markets over the past couple of weeks. The advance in the US market to new highs looks particularly robust, supported by notably strong market breadth.
We do remain underweight the US, relative to global equity indices, on long term valuation grounds but the strength is impressive and could lead to other ‘cheaper’ equity markets catching up with the US as market sentiment improves.
To hypothesise for a brief moment as to why markets are advancing, perhaps it is upon the realisation that fiscal rectitude and austerity are in the rear view mirror. Indeed, over the past week we have seen Shinzo Abe in Japan win a clear mandate to continue with his economic plans, which will likely involve further fiscal stimulus. While in the UK stimulus measures are being openly debated, whereas previously the approach was to cut, cut, and cut. With monetary policy likely to remain very supportive, such policies would boost economic growth.
Furthermore, there is the small matter that the equity risk premium (the premium return that investing in the stock market should provide over the risk free rate) remains very high by historical standards at c.6%.
Now this is partially a function of the after inflation risk free rate (the yield on government bonds) moving into negative territory but it is also a function of global equity markets currently trading around average historical valuations.
It therefore remains our view that global equity markets are not expensive and should deliver pretty reasonable returns over the next decade. The journey will be volatile but we should be rewarded with good returns provided we diversify our equity exposure and retain a high quality bias. Skewing portfolios towards better value equity markets should also be rewarded over the long term.
We fully appreciate that markets have been more challenging this year but we are very encouraged by recent market strength and the remarkable silence it has been met with.
As always, please do not hesitate to contact us to discuss our views further.