The Weekly: Beware Raging Bulls


Many readers will be familiar with the phenomenon that bull markets climb a wall of worry. However, the cynics amongst us may suggest that this can breed complacency such that when investors have made significant profits, their tolerance to risk is artificially high as so much has been overcome in the recent past. It does somewhat defy gravity that faced with a building risk of a global trade war, US equity markets continue to reach new highs. There is an assumption that the US stands to gain much and lose little and the rest of the world is vulnerable. Whilst the US equity market is hitting new highs, investors are happy to believe that all will be well.

A step back from the behavioural analysis is useful here. The first 8 months of 2018 have delivered negligible return to equity investors in local currency terms and negative in real terms (after inflation) with the exception of the US where the S&P 500 has hit new highs rising by just over 9.5%. In the meantime, the UK has risen by 0.2%, Europe by 1.2% and Japan by 0.4% whilst Emerging Markets have fallen by -1.7% and Hong Kong by -4.1%, using the last as a proxy for Asia. Within those last two, Venezuela, Argentina and Turkey are in dire economic straits and within Asia, China has fallen by around 20% as Trump’s trade tariffs have intensified.

Looking at that reality, all developed markets have given up the gains enjoyed in January to be largely flat for the year to date with the exception of the US. You could argue that the individual Emerging Market woes, the UK and EU’s Brexit discount plus the impact of US tariffs on China and around the world is fully priced in. However, a further illustration of the blindly bullish sentiment is the fact that the US market rallied when a Chinese trade delegation visited Washington recently in the hope that a deal would be reached, but then didn’t retrace that rally when that delegation left empty-handed.

This is one of the hardest concepts when judging the future investment landscape. We all know this bull market will end and it will end painfully with a 20% or more fall, the so-called technical definition of a bear market. This normally occurs when the market perceives a change in the investment environment which is not priced in and there is an associated reduction in earnings forecasts and a rush for the sell button, which causes an over-action as investors try to beat the herd, then panic. The purist form of human investor behaviour psychology on which many tomes have been written.  

The fundamentals are only as good as the forecasts on which the numbers are based and the technology sector and the big multinationals such as Apple continue to push ahead. In August alone, this company’s value rose by 20% as it became the world’s first $1 trillion company. Over the last 4 months, it has risen by 38%! Now we all know and love its products but is this realistic? Its value has risen over that period by significantly more than the individual capitalisation of many of the familiar companies in our own FTSE-100 being more than £20bn. You could understand this if a new killer product or application had been launched but this has not been the case and can hardly be rational.

Of course, one company’s performance doesn’t inform an overall market conclusion but it is a symptom of investor behaviour and could be a bellwether guide. This follows the record Q2 reporting season that the US market has just enjoyed. A record 80% of results beat their forecasts, annualised GDP is over 4%, unemployment is below 4% and many statistics are the strongest they have been since the initial credit crunch economic rebound that occurred in 2010. We have been looking through all this great news and examining the behavioural biases that may be going on because it seems strange to us that 80% of analysts had undercooked their earnings forecasts for Q2.

For this, we take note of major historical tax changes in the past. When businesses and consumers are aware that a cheaper or more expensive environment is coming, they naturally delay or bring forward their expenditure. We would argue, in the case of Trump’s tax cuts, which came into force at the beginning of the year, that any finance director worth his salt would delay booking profits into 2018, and we all know that there is significant flexibility as to when a company recognises profits for tax purposes. This was one of the features that led to the demise of Carillion as revenue was being recognised when contracts were awarded and not when perhaps half were completed, entirely completed, invoiced or when cash was received. We would contend that the Q1 and Q2 revenue numbers have been boosted by this feature.

Worse still, businesses and consumers know that higher prices are coming as Trump pursues his tariff policy. Natural human psychology would be for businesses to buy as much stock as possible, especially if affected by steel and aluminium prices, to delay the impact of the tariffs on their business as long as possible. Also, consumers wishing to buy affected goods, especially imports from China, will also bring forward their purchases, possibly even stocking up on non-perishable imports before the tariffs come in. All this serves to artificially boost economic performance and is a one-off benefit which will drop out of the economy as the year progresses.  

The closest analogy in the UK is when multiple purchase Mortgage Interest Relief at Source (MIRAS) was abolished back in August 1988. There was a deadline when this was introduced rather than at 6 pm on the evening of the offending Budget Statement, as happens now. This led to a stampede to get on the housing ladder, a boom, a bust and economic recession. We are hesitant to make such a bold prediction but when much in the US economy is breaking records, and some of those are hard to reconcile in fundamental terms, it would be wise to prepare for a tempering of this enthusiasm, dare we say exuberance, given the tax and tariff distortions. Greed shows itself during profit accumulation, the protection of that profit and the fear of losing it. When the bulls run for cover, they rarely depart quietly and rationally.


US Indices Reach Record Levels Once Again

The S&P500 and NASDAQ showed no signs of slowing down as both equity markets pushed higher once more. It was the best August for US markets since 2014 and a fifth positive month in a row with the S&P adding a further +0.9% and the NASDAQ jumping by +2.1% last week, their third straight weekly advance. The tech-heavy NASDAQ breached the 8,000 threshold for the first time and general sentiment benefitted from progress on a new trade agreement with Mexico. The question is, how long can the streak carry on for?

Whilst US equities were powering forward, it was a different story elsewhere with UK and European stock markets struggling. Domestically, the FTSE100 had a difficult end to the week as ongoing Brexit concerns continued to dominate investor thoughts. Tech and telecoms shares also weighed on the index with it declining by -1.9%. Across the Channel, the German DAX30 and French CAC40 slipped by -0.3% and -0.5% respectively whilst in Japan, the Nikkei 225 moved into positive territory for the year after a weekly gain of +1.2%.

Sovereign bond markets at home and in the US had a largely uneventful week with 10-year yields largely unchanged, the UK Gilt closing the week at 1.34% and the American Treasury at 2.86%.

Emerging market currencies remained under major pressure as investors continued to flee to safer assets. In Argentina, the Peso declined by -25.0% against the US Dollar, despite the government hiking interest rates by +15.0% to 60.0%. Unsurprisingly, it is the worst performing EM currency YTD, having fallen by -40.0% in August alone. The Turkish Lira, South African Rand and Brazilian Real have also endured a torrid time this year. Closer to home, Sterling bucked its recent downwards trend with weekly gains against both the Dollar (+1.1% to $1.30) and the Euro (+1.0% to €1.12). 

In the Commodity markets, oil was back on the front foot with Brent crude rallying by +2.1% to $77.42 a barrel, thanks in part to falling Venezuelan output and reduced US inventories. Gold remained volatile and despite some mild weakness in the Dollar, ultimately closed the week -0.4% lower at $1,202 an ounce.


Week Ahead

Bank of England Governor Mark Carney is scheduled to speak on Tuesday about the central bank’s policy decision to raise interest rates at its last meeting in August, as well as commenting on some of the detail of the banks inflation report.  Meanwhile, the latest Purchasing Managers Index (PMI) data is published this week on both sides of the Atlantic which is one of the more forward-looking indicators of economic growth. The data assesses business activity levels and is due for both the Services and Manufacturing sectors. 

In addition, the first Friday of the month brings the latest US Labour Report which looks set to deliver another positive set of numbers. The US unemployment rate is forecast to stay at just 3.9% and the change in non-farm payrolls is expected at 190,000. Investors will be keeping a close eye on wage growth which has remained steady at fairly modest levels for a number of years now.