In December 2022 we said:
“If you took a strong view on markets in 2022, whether up or down,
it was a ‘A Year Of Pain’, as the FT put it”
Now in 2023, some investors are determined to fight back, pushing prices higher. This means risks are rising, particularly in the US and global debt markets, even while opportunities come into view elsewhere. Striking a balance is not easy.
It began in October 2022, when a wide range of financial markets recovered slightly. We acknowledged this in December:
“The investor mania still simmers, and explains the ‘inexplicable market rally’ of the last two months. That such a ‘buy the dip’ state of mind has not yet been eliminated informs us that the bear market, the downturn, is far from over.”
It was reasonable to assume that this was another bear market bounce – a relatively short-lived recovery within a downtrend, which soon reasserts itself. After all, the dominant US stock market was, and still is, as extremely over-valued as in 1929 and 2000 – nasty precedents which cannot be ignored lightly.
Yet by January 2023, the trash of 2022 was flying. In fact, all financial markets were notably higher. Equities, bonds, commodities, gold, bitcoin, with no differentiation for quality. Such indiscriminate buying is not a healthy sign, and is an echo of the mania, 10 years in the making, which reached a crescendo in 2020/21.
Indiscriminate buying in the short term, driven by emotion, not hard-headed analysis, is one feature of bounces in an unfolding down trend, in this case a downtrend which began in the US on 3rd January 2022.
Now the hard bit.
The result of long-term multi-year bear markets is that valuations return to levels which are reasonable, which is great for investors. We can go further than that. Knowing that markets tend to over-react, down as well as up, at the bottom the markets will not just be reasonably priced, but cheap. That is even better news for investors.
At this bottom, the stock market valuation bubble will have been well and truly popped. But a bubble which has been blown up over 40-odd years will not suddenly “pop” like a real bubble – it will take years. It will merely hiss at first, and it is the hissing phase which we saw in 2022, when most declines were rather orderly. The deflating of the bubble is at an early stage, certainly in the US market.
In tandem with the valuation bubble has been an investor mania – this cannot be measured like valuations, but can be clearly observed in the extreme behaviour of investors. The bottom will be evidenced by panic. Faith in markets will be lost, and most of these investors, previously indiscriminate buyers, will now not buy at any price. Such a panic was not evident in 2022, and recent indiscriminate buying is not what happens at the bottom, on the contrary.
Knowing all of this is useful in understanding the vulnerability of financial markets, but doesn’t inform us as to the stock market’s precise journey as both the bubble and investor behaviour deflate.
For example, in the 1970s the US and UK stock markets went broadly sideways over a decade, but with gut-wrenching falls after the indices toyed with previous peaks. In contrast, other multi-year bear markets started with sharp falls, followed by a long-winded partial recovery, and then an equally long-winded journey to final lows.
Today the centre of the bubble and mania is US financial markets, and other markets typically driven by the mood in the US, such as bitcoin and the cryptocurrency universe.
Yet we cannot judge all other financial markets by this US vulnerability. But as the US is globally dominant, it is a cloud over opportunities elsewhere, whether in the UK or across Asia.
There certainly are a range of opportunities:
- Value-style funds around the globe; cheap-to-good value.
- UK stock market, small and medium-sized companies; ditto.
- Japanese smaller companies; ditto.
- China; good value and re-opening opportunity.
- Asia; good value, growing middle classes, China beneficiary.
- Emerging markets; ditto.
- Commodities; lack of supply plus growing long-term demand.
What we do and don’t know:
- We do know there are clear opportunities (see above).
- These opportunities are multi-year.
- We do not know how the US financial market deflation will unfold…
- … but we should expect downturns to be very sharp.
Balancing these facts is not easy, and there is no perfect answer, but the following approach has the attraction of simplicity and is supported by a depth and breadth of experience and research:
- Don’t get sucked in by the indiscriminate buying of other investors.
- Drip some money into favoured markets gradually, month by month.
- Retain some cash to reinvest at the (unknown) time when there are notable falls.
- Apply a Stop-Loss rigidly (typically on 10% falls).
(The above is an extract from the latest Market Commentary for Dennehy Wealth advisory clients)