Shares are expensive – keep buying them. That appears to be investors’ consensus view. The storming run for stock markets in 2017 seemed almost too good to be trusted, but 2018 has started in similar style.
In the US, the Dow Jones industrial average soared past 25,000 last week, almost exactly 12 months after 20,000 was achieved. In the UK, the FTSE 100 index stands at a record high. Even the Japanese market, for years an international laggard, is back at a 26-year high. Last year the MSCI World index – a proxy for a global stock market – delivered a return of 20.1%. Optimists expect more of the same. The other camp warns that a dangerous bubble is about to burst.
Both sides could probably agree that the recent run in stock markets has been astonishing. Or, rather, the truly remarkable feature has been the steady and unbroken pace of the march upwards. Stock markets, we used to think, offered thrills, spills and rollercoaster rides. Individual shares still provide such excitement, of course, but the overall market seems bizarrely free of stress.
Andrew Lapthorne, who crunches the market numbers for French bank Société Générale, called 2017 “the year volatility died” in his end-of-year round-up. He wrote: “Those of us expecting greater market turbulence in 2017 could not have been more wrong. Not only did global equity markets perform well, but they did so with such low volatility and consistency that, if this were a fund, it would perhaps merit a visit from the authorities to check exactly what you were up to.”
What happened? First, investors seem to have decided that rising interest rates in the US, a big worry a year ago, are not the bogeyman they seemed. The US Federal Reserve has been a protective nurse. Rate rises have been gradual, and ultra-cheap money has been followed by very cheap. A US rate of 1.5% ain’t so bad.
Second, President Donald Trump’s administration, amid its chaos and crises, has delivered the policy investors in companies cared about most: corporate tax cuts. Maybe a growth-generating splurge on infrastructure, the second part of his economic agenda, will follow.
There are no certainties in investment, but the “nothing to worry about” theory is plainly credible. Kenneth Taubes, chief US investment officer at Amundi, Europe’s largest asset manager, reckons the US reforms are “significant” and “not fully priced into the market”.
“Looking into 2018, we believe that the concerns about a bubble for US equities are overdone,” he says. “Compared to past crises [2000, 2007], we don’t see excess in terms of flows. Mergers and acquisitions will likely revive and support the market now that the tax reform has been legislated. Financial conditions are still benign. We expect that the combined impact of an improving US economy, a stronger global economy and lower taxes will support earnings per share growth.”
That won’t silence those who worry about a bubble. On hard and traditional measures such as dividend yields, the US shares look plain over-valued. Prices have climbed so high that the average yield on stocks in the S&P 500, the broadest US index, has slipped below 2%. That implies huge faith in companies’ ability to crank up dividends even further, despite profit margins already being fat.
Or take your pick of any number of signs of market madness elsewhere: the Bitcoin craze; or the fact that European junk bonds, which are supposed to be high risk, were yielding less than safe-as-houses US Treasury notes last month. Amid it all, geopolitics seems to have been forgotten. North Korea? Iran? Saudi Arabia? An imploding US presidency? A Chinese slowdown? None has upset financial markets – yet.
Accurately predicting the timing of the bursting of the bubble, if it exists, is tricky, of course, which is why the forecast of a possible “melt-up” by the normally cautious Jeremy Grantham is so intriguing (see below).
Is a melt-up – a last wild fling for highly valued markets – credible? It’s certainly plausible because it’s happened in the past. To many minds, the dotcom mania seemed crazed in 1998. Then the US tech-heavy Nasdaq index gained 85% in 1999 before the inevitable crash arrived in 2000.
Silly things happen in financial markets.
‘Inflated asset prices and valuations:’ Neil Woodford
Neil Woodford, Britain’s best-known fund manager and a proud contrarian, spent 2017 becoming increasingly sceptical about valuations in many areas of the stock markets. By the end of the year – a poor one for his funds – he was convinced an unsustainable investment bubble had formed and was about to burst.
“Ten years on from the global financial crisis, we are witnessing the product of the biggest monetary policy experiment in history,” he wrote. “Investors have forgotten about risk and this is playing out in inflated asset prices and inflated valuations … There are so many lights flashing red that I am losing count.”
One flashing light was the extreme difference between the performance of US “value” stocks – the type of reliable profit and dividend-earners he tends to prefer – and “growth” companies. The disparity was “greater than at any stage in stock market history”, Woodford said – yes, even including the 1929 Wall Street crash.
Woodford, who manages £15bn, famously sat out the dotcom bubble of the late 1990s and cleaned up afterwards. He sees echoes of those days but thinks there are more similarities with the “Nifty Fifty” bubble in US markets in the late 1960s and early 1970s, which was led by companies such as Coca-Cola and IBM.
“The few stocks that are perceived to be capable of delivering dependable growth have become very popular, and that popularity has manifested itself in extreme and unsustainable valuations,” he argues.
He has sold a few beneficiaries of this trend, such as household and healthcare group Reckitt Benckiser, on the grounds that it is a good but overvalued company. He sees opportunity in domestically focused UK stocks, just as he did in 1992 after the sterling devaluation that followed the UK’s chaotic crash out of European exchange rate mechanism, the forerunner of the euro.
In Woodford’s view, the UK economy is fundamentally healthy in 2018, with more people in work, more wage growth, less inflation, more investment spending and a continued recovery in manufacturing and exports. He is buying UK housebuilders, construction companies, retailers, leisure stocks and property. As for Brexit worries, he thinks they’re as overdone as the turn-of-the-century hysteria surrounding the “millennium bug”, when it was feared that computers couldn’t handle the transition from 1999 to 2000.
‘Look out for extremes of euphoria’: Jeremy Grantham
Brace yourself for a stock market “melt-up”, said Jeremy Grantham this week – a startling prediction from a generally bearish investor, who is regarded as one of most insightful historians of financial bubbles.
Grantham is the British-born veteran fund manager who in 1977 co-founded Boston-based GMO, which today manages $75bn (£55bn) of assets. The firm’s fame partly derives from its skill in having identified, and dodged, the last two big market blow-ups – the dotcom bubble of 1998-2000 and the US housing crisis that preceded the financial crash of 2007-09.
His “melt-up” theory starts from the premise that, yes, markets – or, specifically, the US stock market – are highly priced. The data is “clean and factual”, he says. “We can be as certain as we ever get in stock market analysis that the current price is exceptionally high.”
But there’s more to bubbles than just high prices, he argues. “Among other factors, indicators of extremes of euphoria seem much more important than price.”
Grantham’s argument, in essence, is that signs of real frenzy – the wild excess that accompanies the late stage of bubbles – are only starting to fall into place now. “We know we’re not there yet, but we can perhaps see some early movement,” he says. Bitcoin, for example, is “a true, crazy mini-bubble of its own”.
He defines a bubble as being “excellent fundamentals euphorically extrapolated”. In recent years, market fundamentals have been disappointing – share prices, in the old phrase, were “climbing the wall of worry”. Now, though, the fundamentals are improving, creating conditions for excess. President Trump’s corporate tax cuts are “very likely to further fatten the corporate share of the GDP pie and perhaps provide the oomph to keep stock prices rising”, Grantham says.
There’s another, more technical, point: the rise in the US market (perhaps unlike the Brexit-influenced UK one) has been broadly based. In classic bubbles, the market tends to be led higher in its last stage by an increasingly small collection of “winners”, whose gains outweigh the majority of “losers”. That process hasn’t happened yet in the US.
A word of warning. Grantham isn’t saying a “melt-up” phase is certain; he’s merely saying it is likely within the next six months to two years. And if “melt-up” happens, then prepare for meltdown: Grantham thinks there would be a 90% chance that the US market would fall 50% from its peak.
CRAZY TIMES, CRAZY PRICES
Leonardo da Vinci’s painting of Jesus Christ was sold at auction for $450m in November, about three times more than expected and way beyond the previous record. When Picasso’s Les Femmes d’Alger fetched $179m in 2015, the auctioneer who sold the cubist masterpiece predicted the figure would not be exceeded at auction for a decade.
The cryptocurrency is a bigger speculative gamble than the Dutch tulip mania of the 1630s and the South Sea bubble of the 1720s, according to calculations by asset manager GMO. The Nobel prize-winning economist Paul Krugman says of Bitcoin: “There’s been no demonstration yet that it actually is helpful in conducting economic transactions. There’s no anchor for its value.”
The fast-food delivery company joined the FTSE 100 index at the end of last year. It is worth £5.5bn, slightly more than Sainsbury’s, whose profits are about five times as great.
Argentina has defaulted on its debts eight times in the past 200 years, most recently in 2001. So who would want to buy a sovereign-backed bond that matures in 100 years’ time? Plenty of people, it seems. Argentina’s issue of $2.75bn of bonds last June was heavily oversubscribed. NP