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Abu Dhabi, UAEFriday 20 July 2018

Beware: the bears are coming out of hibernation

Fear around a tit-for-tat trade war and rising interest rates is beginning to unnerve equity market investors

Traders work on the floor of the New York Stock Exchange. While there are still arguments supporting equity markets, policy risk hovers on the edge of investors’ peripheral vision. Brendan McDermid / Reuters
Traders work on the floor of the New York Stock Exchange. While there are still arguments supporting equity markets, policy risk hovers on the edge of investors’ peripheral vision. Brendan McDermid / Reuters

“Bull markets don’t die of old age” is a piece of trader wisdom trotted out to justify hanging out in stocks in a bid to try and squeeze out the last of any potential gains in a cycle. But as market lore goes, this piece of advice may now be injurious to your financial wealth.

It’s true that buying on any dips as a strategy in recent years has stood investors well. The combination of central bank quantitative easing and low bond yields has forced investors to take on more equity market risk in the hope of improving returns.

The old market trope suggests bull markets instead die of excess - too much hubris, and too much leverage. But there is one more reason: policy mistakes. Whether it is the Federal Reserve lifting rates too quickly or President Donald Trump igniting a trade war spark that turns into a brushfire, policy risk hovers on the edge of investors’ peripheral vision like a bad tempered wasp at a picnic.

There are clearly still arguments in support of equity markets. Namely, strong earnings and a moderation in share prices since the start of the year that has improved the valuation picture.

Nandini Ramakrishnan, global market strategist at JP Morgan, is still positive. “In the second half of the year, we expect some reacceleration of growth outside the US as … employment growth and cheap credit… reassert themselves,” she says. “We expect modest gains in equity prices by year-end as government bond price drift lower.” The team at JP Morgan still sees improvements in productivity emerging in the US that will underpin markets there.

But, the escalator of fear around a tit-for-tat trade war and rising interest rates is beginning to unnerve investors.

Ralph Jainz, who manages money at Centricus Asset Management, says: “Central bank support is starting to fade, even as the global demand environment is deteriorating.” He thinks investors need to start positioning themselves for a market that is rolling over: “We would expect a full-blown trade war in European equities to start in in the first half of 2019 at the latest.”

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As for the argument that bull markets die in euphoria, Mr Jainz said it was a question of looking in the right place: tech stocks. “Technology is undoubtedly in a bubble, and overheating phase. That is clear from looking at the gap between growth (eg tech) stocks and value (eg banks) which is at its highest since the first quarter of 2000.”

For some, the markets are already involved in a long drawn-out topping process.

Stewart Richardson, chief investment officer at RMG Investment Management, says this growth cycle is getting old. “This cycle is similar to other cycles, in that previous loose policies encouraged new debt that will eventually prove not to be serviceable and will have to be written down,” he says. “The build-up in corporate debt in particular … is of concern.”

While Mr Richardson acknowledges there may be further upside for equities because of the strength of the US economy, markets are living on borrowed time. “Equity markets have struggled to make progress in recent months. What’s important to try and understand (assuming we are late cycle), is that we are dealing now with a sequence of outcomes that will lead to increasingly less good and then bad outcomes,” he says.

The bears have not had an easy time in this phase of the markets. February’s volatility melted away, once again encouraging the bulls to increase their weightings in risk assets.

But potential triggers for renewed weakness abound: debt levels, margin pressures, valuations, interest rates etc, choose your excuse. But ultimately, confidence is key, and investor and business confidence appears increasingly dented by the risk of mistakes on trade and monetary policy. And that explains why the bears have woken up again.

Geoff Cutmore is co-anchor of Squawk Box, CNBC’s flagship show in Europe

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