The state of play in the stock markets

Which way are markets heading?

As stock pickers, it can be tempting to concentrate solely on company fundamentals and ignore all the distracting chatter about the ‘big picture’. While economists and pundits shout about bubbles, quantitative easing and Crimea, we can just get on with researching great stocks.

However, no one invests in a vacuum, and sadly, few of us have the luxury of just finding nice stocks and leaving it at that! Having a good feel for the overall market and which sectors and themes are working can be vitally important.

Lately, there have been some spectacular and rather uncomfortable moves in the equity markets. But bull markets are prone to sharp corrections, so the current turbulence might be nothing to worry about.

On the other hand, no one ever rings a bell at the top to tell you the market has peaked and is heading decisively south! So I thought I’d use this Penny Sleuth to share my current observations about the state of play for investors.

Are we heading for a crash?

So, what’s been going on? Well on the face of it, nothing more than a very modest pullback. Most developed market indices are off about four or 5% from their highs recorded around the beginning of March.

In fact, the S&P 500 made its high as recently as a fortnight ago and is only down about 3% since. Not much to talk about then. However, this relative calm on the surface masks a lot of ‘rotation’ within the market.

Rotation is a euphemism for sharp falls in stocks that were previously leading the way upwards. The flip side of this is better performance from themes that were out of favour until very recently.

Now, this could be a temporary effect – a partial re-tracing of moves that had got a bit extended. Or it could mean something more significant and lasting. Let’s look at some of the evidence.


Sign up for a 4-week FREE trial of MoneyWeek magazine

MoneyWeek magazine signup

"The only financial publication I could not be without."
John Lang, Director, Tower Hill Associates Ltd.


Bad news for biotech

The most striking falls have been in the highly-rated biotech sector. The Nasdaq Biotech index in the US has dropped 22% since the end of February. This sector had been in the vanguard of the bull market, rising by over 200% in the last two and a half years.

This strength was down to the industry’s exciting prospects with innovative drugs addressing unmet clinical needs. A strong story like this helps when propelling shares ever higher and this momentum can end up attracting new investors all on its own.

Often this leads to valuations getting ahead of themselves and the spell was broken last month when the US authorities questioned the high pricing of Gilead’s new hepatitis drug, Sovaldi. This proved the catalyst for a 20% fall in a share that is very much a sector leader.

The broader tech sector has also been outperforming for the last two years and was a natural candidate to be hit by this change in sentiment. The Nasdaq index is down about 9% and the effects can also be seen over here. Some of my smaller UK tech stocks have been hit and there have been some eye-catching casualties among the larger names.

ASOS, the biggest Aim stock and a poster child for internet retailing, has lost a third of its value since late February. The Ocado chart is almost identical, only the scale of decline is larger at 45%.

In healthcare, Abcam, the life science reagents company, has seen its market value drop by around 30% from the £1bn mark it reached during the winter. This is part of a pretty comprehensive shake-out.

But it’s not just high price/earnings and high growth stocks that have been damaged. A lot of the more economically sensitive sectors like house builders, transport, leisure and retail have been poor over recent weeks.

The flip side is a better performance from more defensive utilities, oils, and food and beverage companies. At first glance this seems odd when we’re in the middle of a lot of good news on the economy.

However, it’s normal for the stock market to look well ahead at times like this and start to discount the first rise in interest rates. After all Mark Carney did flag up a 7% unemployment rate as the level at which the Bank of England might consider tightening policy. He famously withdrew this “forward guidance”, but we might be closer to a rise in rates than many think.

Reports of a market correction have been greatly exaggerated

Another asset class seeing some benefit from rotation is emerging-market equities. I take some comfort from this – and not just because I’m a long-term fan of the developing world.

If we were about to see a market crash, I doubt higher-risk emerging equities would be picking up. Over the last month, Turkey and Brazil are up by over 10%, while at the same time, the Nasdaq has been falling. Even Russia has bounced!

So, what are my conclusions? I’m tempted by the argument that this is mainly a bout of rotation out of highly-valued leaders into cheap laggards – from Nasdaq into emerging markets and from Ocado into Unilever.

‘Blowing off the froth’ and ‘shaking the tree’ are healthy market actions, even though it can hurt if you’re caught on the wrong side. I think this is more likely than it being the start of something more serious.

Therefore, I’m looking for the market to repair the damage by churning around here for a while. We might get some new sector leadership; while the stronger stocks among the tech and growth themes should reassert themselves.

This might take some time though, especially if it turns out we’re starting to discount the first steps towards more normal interest rates.

In our post-crisis world it’s impossible to read the interest rate cycle with any confidence. But I feel I want to tread a little more cautiously for now. And as a stock-picker, I want to own shares I’m really sure of.

This article is taken from our FREE penny share investment email Penny Sleuth.
Penny Sleuth is our FREE twice-weekly penny share investment email. Top penny share expert David Thornton will help you master the world of small cap investment. Each and every week he will pass on his simple, plain-talking insights and expertise that really could change your fortunes. Please enter a valid email address

To sign up enter your email address.



Information in The Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do

[xyz_lbx_custom_shortcode id=4]

• Stay up to date with MoneyWeek: Follow us on TwitterFacebook and Google+

Comment on this article

MoneyWeek magazine

Latest issue:

Magazine cover
The future of motoring

Profit as cars get connected

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking