The Pieces Fall Into Place

Fri 19 Apr 2024

By Brian Dennehy

Access Level | public

Market commentary


quoteLast week’s inflation numbers in the US (inflation went up, which wasn’t meant to happen) established that we are definitely in a period of inflation volatility, and this will likely continue for a number of years.

The good news is that history highlights what sectors should work in this environment in the years to come e.g. Value investments, equity income, commodities.  With UK rate cuts just ahead (probably), it is time to begin to embrace these sectors, as a multi-year theme.

“Begin” is the operative word, as these sectors are not immune from the US bubble bursting, nor a crisis triggered by the mountain of poor quality debt globally, nor a host of other risks ranging from financial to geopolitical and climate.

Plus, while cash has been a sensible asset allocation in the last 12-24 months, it is now the time to consider those other strategies with UK interest rates set to fall.

As well as those opportunities, which we list later, from your personal point of view it is important to get a feel for what we call the “Two Cycles Clashing”.  But first let’s explore why it remains very important not to do something stupid investment-wise, and the facts about where markets are today.


Not Doing Something Stupid

“The problem with the world is that fools and fanatics are always so certain of themselves,

and wiser people so full of doubts.”  Bertrand Russell

Trying not to do something stupid is commendable when investing, though “not doing something stupid” is relative.

On the one hand, if you don’t watch where you are walking on a cracked pavement you risk falling and breaking your wrist or ankle or both.  Painful, but not terminal.

On the other hand, if you don’t pay attention walking along a cliff top you risk very serious injury and death.  You don’t recover quickly, or at all.

Before you invest you need to know if there are merely run-of-the-mill cracks in the market, in which case no need to panic.  Or if the markets are on a precipice, in which case great care is required.

Thankfully you don’t have to guess on this, as there are many precedents through the rich history of financial markets, which we look at next.  Once you have this perspective it is like the scales being lifted from your eyes, and we are all much less likely to do something stupid.


The Facts

“Based on dozens of measures… current market conditions

now cluster around the worst 0.1% in history.”  John Hussman

“Prices reflect near perfection, yet today’s world is particularly imperfect and dangerous.”

Jeremy Grantham, GMO

No one deliberately invests at the top of an investment market, that would be bonkers, irrational.  But for most investors (whether wealth managers or DIY investors etc) it is not the rational part of the brain which kicks into action when you invest – we have covered this many times before and will do a refresher in the next couple of months.

To avoid the emotional brain taking charge, more sensible investors focus on facts.  They try and avoid predictions, don’t read tips from pundits, and aren’t impressed by sales patter – they stick to relevant facts.  It isn’t exciting, but it is extremely valuable if you want to understand the context for financial markets right now, particularly the risks.

These guys are the fact-checkers, often financial history buffs, and typically with at least a couple of decades of experience under their belts.  As noted last time, these are the complete opposite of the believers, who think that details and facts are for wimps, and they just want to pile in – not forgetting that most of them do this with someone else’s money, perhaps your money.

It is the believers who have driven up the US stock market, as they are seldom distracted by facts or guided by history, and are flush with certainty on the apparently easy pickings.  It has always been thus when inflated financial markets linger around their peaks.

They won’t be distracted by research from GMO’s Jeremy Grantham:

There has never been a sustained stock market rally starting from this point” says Jeremy on the US stock market over-valuation (with the CAPE* ratio at 34).

“Never” but for two exceptions:

  • The last 18 months before the crazy Japan peak in December 1989, from which it has taken 35 years to recover.
  • The U.S. tech bubble of 1998 and 1999, followed by 50% falls in the S&P, 80% falls in tech indices, and a decade going nowhere.

Perhaps this will be another exception, and there is a further 18 months of an insane bull market just ahead.  No one knows.  But we do all know the risks at whatever point the stock market cycle moves from up to down.  Sorry, we should all know.  Some investors and advisers appear, sadly, clueless as to the risks.

For example, UK-based investors bought more in US stock market funds in the last four months than the combined total of the last nine years.

With everything we know about US bubble valuations, does that make sense to you?  Is this another one of those fantastic indicators of retail investors piling in right at the top?  This isn’t just occurring with pure retail investors, or DIY investors.  UK wealth managers and advisers, worrying that they missed the boat in 2023, have also been buying.  They aren’t buying for investment reasons, but rather for business reasons, to try and calm frustrated clients.

Again guided by history, and reliable gauges of valuation, John Hussman calculates that prospective losses in the globally dominant US stock market are somewhere between 50% and 70% in the years ahead.  Our own basic chart analysis shows similar, which you can see in the January note.

This is more than just academically interesting.

It is also massively important in a very real way.  Investors with the largest sums invested are typically at a vulnerable point in their life cycle, and right now this is clashing with a turn in the cycle for financial markets.


Two Cycles Clashing

The first is the life cycle of the largest proportion of our clients.  They (you too?) are no longer accumulating savings, rather you are harvesting your savings, to provide income through a long retirement.

The second is the economic cycle.  Our clients, and investors generally, have enjoyed 40 years of falling inflation and falling interest rates.  Not for nothing are the Baby Boomers called the luckiest generation.

But there is now a problem.  Those lucky Baby Boomers have now reached the most vulnerable part of their lives at a moment in time when the economic cycle (higher inflation, higher interest rates), and a number of financial markets (though not all) are also very vulnerable.

The risks are made worse by widespread complacency, which has become entrenched over 40 years.  Until 2020 the Baby Boomers experienced little other than a rather benign economic backdrop throughout their working lives.

This complacency is made worse by a massive sales machine – the financial services industry.  It is in their interests to proclaim “nothing to see here”; or “the markets always recover”; or “just buy and hold”… try telling that to people invested with Woodford, or the masses invested in Scottish Mortgage, down 60% at worst.

It would be tragic indeed if the luckiest generation in history, the Baby Boomers, lost their massive advantage through complacency, and, in some instances, a fog of denial.

Thankfully for those who are attuned to this clash of cycles, financial history highlights with some clarity what will work, and these options have been at the centre of our research for a couple of decades.

But there is still a transition to go through, and we are two years into this phase – it has been clunky, as we look at next.


The Trials Of Transition

“The extraordinarily long bull market in equities has not prepared investors for the battles ahead…

…This is not an intellectual exercise, it is a battleground.”  Jonathan Ruffer, manages £26 billion, 330 staff.

In 2018 we expressed the belief that when the 40 year cycle of falling inflation and interest rates came to an end (that has now happened), there would be no one in the investment industry with any experience of a different era, making the transition from the old cycle to the new one particularly uncomfortable – and so it has been, amplified by pandemic, war, and global cost of living crisis.

For example, though 2023 wasn’t a terrible year for investing, with mixes of small losses and small gains.  Nonetheless, the views expressed by some of the most accomplished individuals in financial markets were a mix of frustration and deep reflection “after three years riding a rollercoaster”, as The Economist put it.  For many serious-minded money managers, and also a significant number of self-directed investors, 2023 felt like the last straw.

One manager of £3 billion, and no flash Harry, put it simply:

Too many of the things which were meant to go down went up,

and a few of the things which were meant to go up went down.”

Ray Dalio’s Bridgewater, managing $72 billion, ground out a gain of 7% in the calendar year up to October, yet ended December down 7% for the year – despite the immense input of Ray himself, plus 1,300 employees.

Another manager of $2 billion expressed his frustration thus:

“What worked yesterday isn’t working today and probably won’t work tomorrow.”

Yet opportunities are clear, as you saw in our latest TopFunds Guide (if you don’t yet have your copy, email here to request your free copy).

Let’s have a look at those opportunities, firstly with a little extra on the UK with the General Election being ahead.


UK Aside – General Election Ahoy

You might have noticed that the shadow Chancellor, Rachel Reeves, has been much more visible in the last few week.  Behind the scenes, major financial institutions have been banging on the prospective Labour administrations door for some time, and we are told that the waiting list for an audience is about 3 months.  (In case you are wondering, there is no queue to have a chat with Conservative ministers.)

Rachel Reeves has revealed her inner-Thatcher, and her plan to borrow for growth is straight out of the Liz Truss play book.  Presentation was always the problem for poor Liz, and Rachel Reeves will not make the same mistake.

The historical guide that the election of a left-leaning government will hit the stock market, at least initially, might not come to pass.

In fact since the recent peak for the US stock market on 28th March, the UK stock market stands out amongst developed economies as being the best of the bunch.  (China and India are the UK’s bedfellows in this short period)

Someone has clearly been buying the UK, for so long unloved.  Global buyers have probably been significant.  In contrast the relative attractions of the UK are not being given much credence by the great bulk of UK-based investors, as March 2024 was apparently the 34th consecutive month of outflows from UK retail funds – counter-intuitively, this scale of lack of enthusiasm is often a positive indicator.


Opportunities Around The Globe

Some of these were set out in the last TopFunds Guide:

  • Decent opportunities in the UK, for growth and income investors
  • Asian has clear attractions beyond China
  • Japan remains cheap
  • China is stirring, though it is early days
  • Opportunities in commodities, should persist for years to come
  • European small companies, with help from lower interest rates
  • Value-style funds around the world, again for years to come…
  • …including equity income funds

As mentioned at the outset, it is time to begin to embrace these opportunities, in an appropriately measured way, and being content to step to one side if the need arises.

Lastly, you can see from the above that we are cautious, and our portfolios reflect this.  If your judgment is that you would like to take on more risk immediately, please do contact your usual adviser.


*CAPE is the cyclically adjusted price earnings ratio.  It is a valuation measure that uses real earnings per share (EPS) over a 10-year period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.


Market commentary


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