Keynotes March 11 2015

The top of the World? Global Shares – A Good Time to Invest?


A picture tells a thousand words, or so we are told. The MSCI World Index, which is the composite index representing the shares of companies listed globally since 1969, paints a disturbing picture of the last twenty years which should help dispel any notion that now is a great time to be investing in shares:

 Chart 1 11-03-15(Table 1. Source: FE Analytics)


Of course, as any Cartesian thinker will tell you, pictures often mislead. The chart above is shown in US Dollars. The same chart rebased in Pounds Sterling shows an apparently far less pronounced credit crunch between 2007 and 2009:


Chart 2 11-03-15 (Table 2. Source: FE Analytics)


Then there is the effect of income (dividends) being reinvested (below in red), which greatly improves the picture for shares. I have kept this in Sterling, our investors being UK domiciled and Sterling based:


Chart 3 11-03-15(Table 3. Source: FE Analytics)



390{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} gains led to 50{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} Dot Com Crash and 13 Years of Recovery.


No matter how you present the data, it is an uncomfortable fact that shares globally appear to have shot up more in the last two years than at any time since the Dot Com Bubble burst in August 2000, when it tumbled by more than 50{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} (in Sterling terms) in the two and a half years to mid-February 2003.


The ten year period from the early 1990’s, through the Exchange Rate Mechanism crisis in 1992, saw global shares increase in value by a staggering 310{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} by August 2000, approximately three times the expected average return. This ignores income which if reinvested would have given a Sterling based return of 390{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072}. Roughly speaking the subsequent crash wiped out five years worth of gains and took almost thirteen years for the price to fully recover. With income reinvested it was slightly less at just over eleven years. The lesson is stark: invest into a peak at your peril!


To continue with the history lesson, between the 13th February 2003, the very end of the Dot Com crash and the next Peak, which heralded the start of the Credit Crunch and the global financial crisis on the 23rd May 2007, the global shares markets rose by 77{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} (95{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} with income reinvested). The crash took share prices down by nearly 32{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} (rebased in Sterling) over almost two years to Mid February 2009.


Credit Crunch a Mere Blip in a Long Term Bull Market?


Since then we have seen a 108{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} rise (137{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} with income reinvested) through a period of almost exactly six years. Whilst this cannot be equated to the rise over the ten years to 2000, it is significant that the 2007-09 Credit Crunch, despite it’s economic impact, is starting to look far less significant in market terms than the 2000 crash. It took the markets only five years to recover the peak reached in 2007, less than half the time it took for the Dot Com crisis to play out.


If we view the 2007-09 crisis as a mere blip in a Bull market that runs from February 2003, then the picture begins to look rather different for shares, with this longer period beginning to look far more like the period running up to the 2000 crash.


Markedly Different Returns but What Next?


However, despite the apparent trajectory, the returns are actually markedly different, being roughly half in the last twelve years of what they were in the ten years leading up to the Technology market crashing in 2000, in Sterling and only marginally better when measured in US Dollar terms. So the last twelve years has been relatively subdued, largely thanks to the 2007-09 financial crisis.


The burning question on almost everyone’s mind at the moment is, ‘what is likely to trigger the next crash and what will that crash look like in magnitude?’ These are unanswerable questions but I believe we need to look more at the markets themselves rather than at the economic situation, be that Greece, Russia, Eurozone or deflation, in order to get some insight into what is likely to happen next.


This is difficult to do because we are conditioned to regard economic data as having a significant impact on markets. The facts seem to indicate that, in reality, economic shocks are often only short-term influences on the markets.


True Financial Meltdown but not a ‘Typical’ Bubble and Crash


Markets react more to other factors, which may themselves be influenced by economics and politics but have a far greater bearing on the direction in which the share markets are likely to move. The Financial Crisis in 2007-09 affected all asset classes: bonds, shares, commodities, cash and property. Everything crashed. It was 1929 all over again. It was true financial meltdown and it left global banking in tatters. It scared the share markets but not for long. It was not a typical market crash, if such a thing actually exists, in that it was caused by problems with the way the modern banking system operates, rather than assets becoming overvalued in any way consistent with a price ‘bubble’ as was the case in 2000. Although banks themselves ‘bubbled’, they recovered in a way that most Technology Stocks did not.


Need to Understand Liquidity and How Different Assets Trade


To gain a better understanding and insight into what might happen, we need to understand liquidity and how markets trade in each of the main asset classes. That is to say, shares can be bought and sold quickly and there is a fluid and active market where they can be traded. This is almost unique, in as much as the other investment asset classes cannot be traded in the same way. Commodities are perhaps the closest, being traded on sophisticated trading markets, but in their physical form they have to be extracted, refined and delivered, reducing liquidity and making them less easy to trade when compared with shares. Of course there are all sorts of ways that the market uses to get around these issues, meaning that we still see very big falls and rises in commodities, similar to those experienced by shares. Bonds are traded OTC, meaning ‘Over The Counter’, which is to say that there are only limited markets, with most bonds being bought and sold through the coming together of two parties specifically to buy and sell. The bond market, such as it is, is far less liquid than the share market. Property is even less liquid, with property sales taking months to conclude.


Bonds are generally more susceptible to economic factors such as interest rates and inflation. Commodities tend to be valued by virtue of supply and demand, which may well be determined by the wider economic picture which is similar in this respect to property, but more liquid and easily traded. Shares prices change directly in line with investor expectations of future profits. This is far from an exact science, despite what analysts would have you believe. Investor expectations are influenced by greed and fear, both of which change realistic expectations to something else completely, through what is known as Irrational Exuberance. This means that realistic expectations become unrealistic. It explains why markets fall further than they should in a crash, and rise higher than they should in a bubble, propelled downwards by fear and upwards by greed.


Pre & Post Dot Com – Two Distinct Market Periods


I believe that it may now be possible to see two distinct market periods through which share investors are collectively regarding returns. These are The Pre and The Post Dot Com Bubble periods: 1988 – 2000 and 2000 to 2015 and beyond. The 2007-09 Credit Crunch sits neatly within the post Dot Com period, affecting and defining it, but ultimately only a component of a long term bull market, subdued by comparison to the Pre Dot Com period, but a Bull nonetheless.


Credit Crunch Explains New Share Market Resilience


As I have said in previous reports, the Credit Crunch may in fact help explain the share markets’ overall resilience to economic and socio-political bad news factors. Investor perceptions of danger and risk from economic and political events seem to be anaesthetised. Having survived financial Armageddon, it would take something worse than that to disturb the confidence of share investors in the ability of companies to make them money.


Is Income the Main Attraction or Cause for Concern?


Dividend earnings have proved excellent over the period and even high yield bonds have provided a welcome boost to income for those starved of interest on their cash savings. What’s not to like? Looking back to the red line in Table 3 we should perhaps ask ourselves if it is not the income included in the total return figures that could give greatest cause for concern?


It is a Fair Analysis?


If we then turn to table 1, this shows that for shares valued in US Dollars, the current situation is precarious for price alone. Shares in these terms seem to be riding high. As the vast majority of shares globally are US Dollar denominated this seems to be a fair view.


Of course this World Index takes into account China, India and the rest of the emerging markets. It accounts for a massive recovery in the USA. It takes Japan and Europe into account as well as the UK, providing an average composite world return, which I am sure would be challenged by many as being too broad a brush approach, given the possibilities in the various component markets, which could easily outperform the average in the short term. We saw previously how Japan has provided excellent returns over fairly short bursts and how the same could be true for Europe even if deflation becomes a long term issue.


Currency exchange rates and the fact that I have analysed returns in Sterling also distorts the picture, but not by enough to affect the results or change the conclusions. Ultimately, we have to recognise that the World Index of shares (line C in blue) has provided consistently high returns, driven by the USA’s S&P500 (Line A in orange) over the last two years, and more recently by the leap in Japan’s Nikkei 225 (line B in turquoise) in which the sharpest gains have occurred :

Chart 4 11-03-15 Table 4. Source FE Analytics


So, What Does it all Mean?


Firstly, it is necessary to say that there is nothing to suggest that a Dot Com style Bubble is forming in any specific industrial sector. The growth in global share values is largely a product of the growth the S&P 500 and to a much lesser extent the Nikkei 225.

 Chart 5 11-03-15Table 5. Source:FE Analytics)

 Moreover, the current scenario is less pronounced than the lead up to the Dot Com Bubble bursting. It is however very steep, particularly in the last two years.


Post Dot Com Returns Comparatively Disappointing


In the four and half years preceding the Dot Com crash in 2000 the MSCI World Index of shares grew by 124{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} measured in local currency (mostly US Dollar terms). In the four years and nine months before the peak in October 2007 the MSCI World Index produced 101{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072}. Over the last six years since the end of the credit crunch in February 2009 the index has risen by 124{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072}. In the longer period from February 2003 to date, that we can now refer to as Post Dot Com, that percentage rise has only just been exceeded, meaning that the twelve years Post Dot Com growth has been disappointing, relative to the pre Dot Com era when over the equivalent twelve year period the MSCI World Index rose by 242{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072}, almost twice the growth of the post Dot Com period.


Might be Misleading too…


In the short to medium term this analysis might be meaningless and misleading. Regardless of the comparative growth rates, the current market still looks steep and unattractive. A correction is possible, most likely as a consequence of uncertain political outcomes both here and abroad, through May to December, spanning elections here and in Spain. The latter may well be influenced by what is looking more and more likely to be a forced exit from the Euro by Greece, should they find it impossible to meet their financial targets over the coming weeks and months. Russian aggression in Eastern Europe and the Baltic as well as an overheating property market in China won’t help. Perhaps more significantly, there is the matter of investor expectations of company profitability, which many analysts feel has got somewhat ahead of itself in the last few years.

Chart 6 11-03-15

Table 6. Source: FE Analytics


In this, the final chart of this very chart-driven piece, I have plotted the 360 day moving average value of the MSCI World Index against its real return. This, perhaps better than anything, demonstrates that in the short term at least we should expect trouble, if only as a result of investor greed succumbing to fear, thus dampening what might be considered today’s irrational exuberance.


Expect Trouble


In summary, global markets, driven by the S&P500 and in this analysis represented by the MSCI World Index, appear to be ahead of themselves in the short to medium term and we should expect trouble. Unless there is a compelling reason to be committing one’s hard earned cash to shares exposed to this scenario, it would seem prudent to wait. As always, only time will tell, but now does not seem to be a sensible time to enter the equity markets except for the very long term.


For most of our investors, investment portfolios are diverse and invest in bonds as well as shares. As we have discussed, the risk to the bond market is based far more on economic factors such as gilt and corporate bond yields, interest rates, inflation and potential or actual default rates amongst issuers. Over the last year, most of our portfolios have survived on the basis of the income they produce with little or no capital growth, although this very much depends on the asset allocation between bonds cash and equities.


“Don’t take it from me, take it from Winnie the Poo”


A favourite analyst of this firm, James Montier, in a recent interview with German Language Publication ‘Finanz und Wirtschaft’ and reported on by ‘Business Insider’ said “don’t take it from me, take it from Winnie the Poo: Never Underestimate the Value of Doing Nothing’.


Montier, who is a senior strategist at GMO, one of the World largest investment houses, sees a central bank sponsored bubble forming that he believes is reducing the true value of investment assets leaving very little for investors to hold on to. His company has been selling their shareholdings in US blue chip stocks because they see them as vastly over valued. He was reported by ‘Inside Business’* as saying: “”But let’s say it in simple terms: For all purposes, this is a hideously expensive market,” Montier said. “I don’t care if it’s a bubble or not. It’s too expensive, and I don’t need to own it. But because this is a central bank sponsored near bubble, it hurts to stay away.”


He describes the current share market as one in which investors employ a buy the dip mentality, short term trading the markets, making them greedy, no longer fearing losses, only that they might miss out on future gains. In his view this will create a bubble, with the downside being protected by the central banks. Montier said: “That’s a very tempting thought in the short term, but incredibly dangerous. The central banks will protect us up until they don’t anymore. And you don’t know when that will be.”


For Montier, and I share his view, cash is the principle protection from these risks. Holding cash in our portfolios will provide flexibility and manoeuvrability if and when the markets correct. “Never forget: You can’t know the future. Hold a lot of dry powder now. 50{a1d5745a86653f095ed3386d3dbf7deff8ff78eb8b3be67133b744f07a6e4072} of our portfolio today is in cash or some form of short term bond holdings. If we do get a dislocation in equity markets, we will have the ability to deploy that dry powder. That’s the time to buy.”
For most of our portfolios the downside is already limited by the inclusion of bonds and growing amounts of cash. In general I am not fearful for most of our cautious portfolios but the coming tax year end is an opportunity to revisit these issues, revaluate risk and where appropriate make changes to portfolios to take these views into account.


Chris Welsford



Warning: Investment returns are not guaranteed. The value of investments and their associated income can fall as well as rise. Past performance is not a guide to future returns. This report represents the views of the author and does not constitute investment advice and no action should be taken as a result of its contents. If you feel the issues raised affect you then please contact us as a matter of urgency and we can discuss your specific situation.

* James Montier On Markets – Business Insider 7/12/15