Advertisement

With the magic gone from the stockmarkets, investors must focus on reality

The magic pixie dust behind the stockmarkets’ massive bull run – loose monetary policy – has vanished. Investors must now focus on what really matters: cash and valuations.

181029-stockmarkets
Stockmarket growth has been driven by a central-bank induced illusion

If you have ever taken children to an illusion museum you will know about infinity mirrors. Look into one and the lights around the edge appear to head to infinity. It gives you a sense that the path to the future is both clearly defined and well lit. This is what stockmarkets feel like in periods of intensely loose monetary policy.

Advertisement - Article continues below

When money is constantly cheap and available everything seems straightforward. Markets go up whatever happens, leaving investors free to tell any story they like about why. It is easy to believe that tech companies with profits in the low millions are worth many billions. Or, as one fund manager told me last month, that traditional equity valuation methods are no longer the point all we need to think about before we invest these days is how the company in question can respond to digitalisation.

Nothing else matters. You can believe it is perfectly possible for a company to have no obvious end to its cash-burning stage, but that its valuation will keep rising. Perhaps it is worth financing three separate dockless e-scooter brands on the streets of Madrid, for example? (Last week I spotted Voi, Wind and Lime scooters scattered around the pavements.)

Advertisement
Advertisement - Article continues below

You can believe that the Phillips Curve (which describes the relationship between employment levels and inflation) is genuinely dead: that labour will never regain the power to really make a difference to real wages. Or that, even if it did, workers are becoming such a tiny part of the corporate cost base that it simply doesn't matter to profit margins. And you can believe that global companies will never be subject to the tax or regulatory whims of sovereign governments; that this time everything is different.

It has all been a central-bank induced illusion

It is all an illusion, of course. Turn the power off at the museum and the bright lights of a comprehensible kind of infinity disappear. Turn off the liquidity taps at the world's central banks and so does the ability of the market to believe seven impossible things before breakfast.

Advertisement - Article continues below

That is why nearly all equity markets have had a horrible month. Almost all indexes are down by as much as 14% over the last four weeks, and 24% on the year. The only major markets in positive territory over a year are those in the US and Russia.

The surprising thing here is not so much that markets have tanked, but that given that they are supposed to be discounting mechanisms, taking in and reacting rationally to all available information it didn't happen sooner.

US monetary tightening has not exactly been kept under wraps. The dual approach of cutting its asset holdings while raising rates has been well advertised. The Chinese government's intention to deleverage has been no secret either. Nor has the tapering of quantitative easing in Japan or the intention of the European Central Bank (ECB) to pull back from it completely. The ECB's asset purchases fell from €60bn a month in 2017 to €30bn in January 2018. Its president, Mario Draghi, expects them to halve again in this quarter, with a view to ending them completely by the end of year.

Advertisement - Article continues below
Advertisement
Advertisement - Article continues below

All this tapering and hiking might or might not be a good idea not everyone would necessarily want to tighten monetary policy in Europe at a time when the German economy is looking iffy and Italy is attempting to assert its fiscal sovereignty.

Investors once again have to focus on cash and valuations

Whatever you think of it, there is no doubt that the liquidity lights, if not already off, have been dimming for some time. Suddenly what matters is not how much money is being printed, or when and where, but where we find ourselves in reality. In the case of stockmarkets, that means politics starts to matter again but, in the main, it means investors have to start focusing properly on cash and valuations.

October shouldn't be seen as the end of the bull market (look at the annualised performance numbers for most markets and you will see that it ended some time ago). But this month can be recognised as the point at which the market shifts from being driven by liquidity to being driven by fundamentals. For those badly positioned going into such a change (less thoughtful growth investors, perhaps) this is nasty. For the rest of us it is good news, twice over.

Advertisement - Article continues below

First, some of the things fund managers believed a few months ago could well be true in part. US corporate profits look fine. Around 40% of S&P 500 companies have reported in this earnings season and some 80% of them have managed to produce a positive surprise; digitalisation may well be about to transform productivity in developed economies; and there is as much scope as ever for conventional industries to be wiped out by canny disrupters. (I still firmly believe, however, that Madrid needs between zero and one provider of e-scooters, instead of between one and three.)

Second, stockmarkets outside the US really are not that expensive any more and pockets of them are beginning to look like they offer some value. That should please long-term investors.

It should also be absolutely thrilling to the active investment industry. This sort of shadowy environment is exactly the kind in which they can have another go at proving their special stockpicking skills are worth paying for.

Advertisement
Advertisement

Recommended

The British equity market is shrinking
Stockmarkets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
BP has slashed its dividend – and markets love it
Income investing

BP has slashed its dividend – and markets love it

BP has bowed to the inevitable and cut its dividend in half – and its share price promptly rose. John Stepek explains what it means for shareholders …
4 Aug 2020
Listed companies are dying out, and that could have serious consequences
Stockmarkets

Listed companies are dying out, and that could have serious consequences

Private equity is taking over from public stockmarkets as the biggest provider of capital to companies. That’s bad for investors and bad for society a…
3 Aug 2020
The revolutionary potential of 5G
Sponsored

The revolutionary potential of 5G

SPONSORED CONTENT – With the right investment and support, the next generation of connectivity could transform society
3 Aug 2020

Most Popular

Can the recent rally in sterling continue?
Sponsored

Can the recent rally in sterling continue?

A "double top"  – a very recognisable pattern – is forming in in the US dollar. Dominic Frisby explains what it is, and what it could tell us about st…
3 Aug 2020
UK banks have had a shocking week – so it’s probably a good time to buy
UK stockmarkets

UK banks have had a shocking week – so it’s probably a good time to buy

Lloyds Bank reported a £676m loss this week. And, with all of the UK's high street banks having a terrible time of things, bank stocks are detested ri…
31 Jul 2020
Gold bugs' dreams are coming true – but we could still see a V-shaped recovery
Gold

Gold bugs' dreams are coming true – but we could still see a V-shaped recovery

John and Merryn talk about how it's perfectly reasonable to expect a V-shaped recovery and to continue holding gold as well. Plus, inflation, staycati…
30 Jul 2020