Reasons for investors to be cheerful

Merryn Somerset Webb may not be wildly bullish about equity markets, but here she channels her inner Tigger to find reasons to be positive.


Don't worry, be wealthy?
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Last week, I asked what might bring the world's great bull market to an end. I had lots of Eeyore-style answers of my own to the question. As expected, some of you wrote in to tell me that they were all wrong.

This bull market, some readers said, won't end any time soon. It isn't long in the tooth; it can cope with rising interest rates; and, contrary to popular opinion, it isn't particularly overvalued.

This is a perfectly reasonable view and one that has inspired me to dig deep in search of my inner Tigger. If you can be bullish, and the chancellor, Philip Hammond, certainly is, then I can try harder to be more bullish too.

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Let's start with the long-in-the-tooth business. It has become standard practice to say (as I did last week) that the current bull run in the US and the UK is the second greatest ever in terms of both its length and the scale of returns something that should automatically ring alarm bells, as all good things come to an end.

However, you could argue that a bull market doesn't start when a bear market hits bottom (as the last one did in 2009), but when markets break through the high point of the previous bull.

That only happened in the UK in April 2015 when the FTSE 100 broke through its 2000 high of 6,931, notes one rather pedantic reader. And on that reckoning, the current bull market is both young (less than three years) and, so far at least, pretty unenthusiastic (the FTSE 100 is lingering around 7,100, so no overexcited animal spirits there).

Based on the performance of the S&P 500, the US bull market is much the same age. You could also argue, as analysts at Ned Davis Research do, that the bull is even younger than that. Play with the numbers and you can show that there have been two bear markets since 2009 (2011 and 2015-16) making this bull a mere two years old.

Practically an infant! There is endless fun to be had here, but I'm going to leave the rest of the numbers manipulation game for someone else. I am not convinced for a second that the age of a bull market makes much difference to the timing of its demise.

It's not a very old bull market and it's not wildly expensive

Its longevity isn't that different to that of a person. It can die of an unexpected short, sharp shock (cyber or trade wars look like the ones to watch today). Alternatively, it could live on for much longer than anyone ever thought possible, particularly if the environment changes (think amazing medical advances for people and long-term abnormal monetary policy for markets).

Next up, valuations. Can you really argue that today's markets are not expensive? Actually, you can. Russell Napier, author of Anatomy of the Bear, the definitive book on market bottoms, reckons that equities in the US have since 1881 only twice been as expensive as they are now.

However, he bases that on the Cape ratio (cyclically adjusted price/earnings ratio). This divides the level of the S&P 500 by the average annual earnings per share of its constituent companies over ten years, and has an excellent record as a long-term forecaster of market direction.

Currently, the Cape ratio is well over 30 double its long-term average, so potentially a bad sign. Yet not everyone thinks that it is telling us the whole truth about markets today.

For starters, the denominator (the average earnings) is hugely depressed by the inclusion of the recession level earnings of 2008-09. Accounting changes also pushed down the earnings used in the equation at the time, says Capital Economics, a research group. Adjust for that and today's Cape ratio is more like 26 than 33.

Add in a couple of other adjustments, such as sustained low interest rates leaving investors willing to accept lower returns from equities than ever before, and you can get it down to 24-ish. Take out the most expensive of the tech companies, and you can go even lower. That's still expensive but not completely nuts.

The US market is on a "melt-up"

It is also worth noting that the numerator, in the US at least, appears to be on the way up. US markets guru Ed Yardeni published a note this week entitled Don't Worry, Be Wealthy.

He says that something unusual (in a good way) is happening in the US market. It is in a "melt up". The S&P 1500 index, which covers 90% of US-listed stocks, has seen its market capitalisation rise by $6.6trn since Donald Trump was elected president, but he argues that "it's a very unusual earnings-led melt up".

When stockmarkets seem to go mad, usually all that is happening is that valuations are expanding (note that price/earnings (P/E) ratios soared in 1929, 1987 and 1999). But this time that isn't the case. Instead, most of the gain in stock prices over the past year is due to "rising forward earnings, rather than rising forward P/Es".

In the past six weeks alone, says Dr Yardeni since Trump's Tax Cuts and Jobs Act passed "industry analysts have raised their 2018 consensus earnings-per-share estimate by $7.16 to $153.42. Their 2019 estimate is now $168.94, up $7.87 over this period."

Even US steel producers are seeing their strongest earnings in a decade. Add in the rise in productivity that will surely feed through from digitalisation any day now, and these are exciting times for earnings.

That raises the odds that the US might be seeing a rare and special thing: a melt up that is not immediately followed by a melt down. A safer type of mania perhaps.

The UK market is hugely unpopular with investors

Shift your gaze back to the UK, and you will see we don't even really have to worry about melt up being followed by melt down as we aren't really having the former.

Thanks to Brexit and fears of prime minister Corbyn, the UK stockmarket is hugely unpopular with global investors. Short sales are as high as they were in 2009. As a result, the UK is (on UBS numbers at least) one of the cheapest markets in Europe, particularly if you look only at domestically orientated stocks, which are 15% cheaper than exporters.

So there you have it. I am, as regular readers can imagine, not 100% convinced that this happy state of affairs can last much into 2019. But there is definitely some reason to be more Tiggerish on markets than you might think at first glance and Tiggerish about the UK in particular.

With that in mind, one fund to look at is Richard Buxton's Old Mutual UK Alpha fund. It is concentrated (34 holdings) well-priced (the management fee is 0.85%) and it holds a host of good-value UK companies. Don't worry, be wealthy.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.