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Are the markets running on borrowed time?

Tom Stevenson  |  06 Sep 2017Text size  Decrease  Increase  |  
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In light of the new high for Nasdaq and general market strength, Fidelity's Tom Stevenson revisits an old list of market peak signals.


Eight and a half years after markets bottomed in the wake of the 2008 financial crisis, it is entirely reasonable to worry that this bull is running on borrowed time. The US stock market, which has led the charge, has risen by 265 per cent since 9 March 2009 from under 700 to nearly 2,500. One of the stock market's greatest-ever rallies has crept up on us.

There has been plenty to worry about but stock market investors have been happy to shrug off the geo-political angst. If the potential for nuclear conflagration can't derail this long-in-the-tooth bull market, it's hard to think what might. Are markets right to put greater weight on a decent earnings season than the Trump-Kim stand-off? Or is this the complacent lull before the autumn storm?

Sadly, my old friend British financier and investor Jim Slater is no longer here to share his view. I remember our lunch in late 1999 when he concluded there was nothing left to buy just a week or so before the dot.com bubble burst.

He had a sixth sense about market turning points, like an animal heading for the hills as the tsunami approaches. Instead I have had to make do with revisiting the check-list of market peak signals from his 1993 book Investing Made Easy.

Despite my uneasiness with rising share markets around the world, hardly any of Slater's alarm bells are ringing today.

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1) Top of his list is the observation that cash is viewed as trash at a market top. The evidence here is mixed. The latest Bank of America fund manager survey showed average cash levels at 4.9 per cent, which sounds low but is actually slightly above the long-term average. Funds benchmark themselves against equity indices and so they tend not to ever hold much cash. This is quite a cautious position.

2) The second signal is an absence of value. On the face of it, this is certainly flashing red. A long-term valuation measure devised by Robert Shiller at Yale University is currently more expensive than 97 per cent of all readings since 1881. It's only been more expensive ahead of the 1929 and 2000 market crashes.

3) Slater's third signal is definitely red. Interest rates are usually about to rise or have started to do so when markets peak, he says. Tick. Ditto the fourth signal which says that money supply tends to be contracting at the turn of bull markets. Given the imminent reversal of quantitative easing in the US, and probably Europe too, we are clearly close to a turning point in liquidity.

4) The fourth sign, unemployment, feels like something that worked better in the pre-QE era than it does now. Slater thought that the market tended to run out of steam a few months after unemployment turned down. I guess the thinking here is that the market tends to pre-empt real economic changes and then move onto the counter-trend. With unemployment having been declining for many years, this ought to be a negative for the market.

So far, this all sounds a bit worrying but move further down the list and the case for an imminent correction looks less compelling. Three of the remaining signals are really variants on the theme of sentiment.

5) 6) & 7) Signal five is a bullish consensus among investment advisers, six is an enthusiastic media, and seven is dinner party chit-chat. In this most grudging of bull markets, sentiment has never approached euphoria. The Bank of America survey shows 45 per cent of investors having a bearish view on markets. There's a distinct absence of optimism in the press. I don't go to many dinner parties, but as far as I can see the obsession is still house prices and schools, not stocks and shares.

8) I see nothing to worry about in signal number eight either: reaction to news flow. Typically, at the top of a bull market shares start to respond negatively to good news. After years of rising markets, it's all in the price. There's no sign of this. Exhibit A here for me was the recent announcement by Chinese online retail giant Alibaba that it expects revenue growth to rise to nearly 50 per cent. When Alibaba unveiled its new growth projections to investors this summer there were gasps of amazement and the shares rose strongly. They are up more than 40 per cent this year alone and have nearly trebled since the beginning of last year.

9) Slater's ninth sign, a growth in the number of new issues, is also largely notable by its absence although his related point, deterioration in their quality, is not. The flotation of Snap and its subsequent underperformance was not the bubble-defining moment that Lastminute's flotation was in 2000. I would not be surprised, however, if we look back on Snap's failure as a straw in the wind.

10) The tenth signal, a change in market leadership from steady growth to more cyclical shares, is interesting. Six months ago, the Trump Trade was built on precisely such a risk-on-again shift. It caught many quality-focused investors on the hop. But it was short-lived and defensive quality is back in fashion again. This flight to safety is behind the resurgence of technology in August, a perceived winner in a low-growth world.

So, of the ten signals here I'd say only three--valuations, liquidity, and interest rates--are really flashing red. I'm personally nervous and have a higher cash weighting in my portfolio than for many years. Perhaps that's the most positive sign anyone could ask for.

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Tom Stevenson is an investment director with Fidelity International. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.

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