In December 2022 we said: “If you took a strong view on markets in 2022, whether up or down, it was a ‘A Year Of Pain’, as the FT put it”
Now in 2023, some investors are determined to fight back. This means risks are rising, particularly in the US and debt markets, even while opportunities come into view elsewhere. Striking a balance is not easy.
It began in October 2022, when a wide range of financial markets recovered slightly. We acknowledged this in December:
“The investor mania still simmers, and explains the ‘inexplicable market rally’ of the last two
months. That such a ‘buy the dip’ state of mind has not yet been eliminated informs us that
the bear market, the downturn, is far from over.”
It was reasonable to assume that this was another bear market bounce – a relatively short-lived recovery within a downtrend, which soon reasserts itself. After all, the dominant US stock market was, and still is, as extremely over-valued as in 1929 and 2000 – nasty precedents which cannot be ignored lightly.
Yet by January 2023, the trash of 2022 was flying. In fact all financial markets were notably higher. Equities, bonds, commodities, gold, bitcoin, with no differentiation for quality. Such indiscriminate buying is not a healthy sign, and is an echo of the mania, 10 years in the making, which reached a crescendo in 2020/21.
Indiscriminate buying, driven by emotion not hard-headed analysis, is a feature of an unfolding down trend.
Now the hard bit.
The consequence of long term multi-year bear markets is that valuations return to levels which are reasonable, which is great for investors. We can go further than that. Knowing that markets tend to over-react, down as well as up, at the bottom the markets will not just be reasonably priced, but cheap. That is even better news for investors.
At this bottom, the stock market valuation bubble will have been well and truly popped. But a bubble which has been blown up over 40-odd years will not suddenly “pop” like a real bubble – it will take years. It will merely hiss at first, and it is the hissing phase which we saw in 2022, and most declines were rather orderly. The deflating of the bubble is at an early stage, certainly in the US market.
In tandem with the valuation bubble has been an investor mania – this cannot be measured like valuations, but can be clearly observed in the extreme behaviour of investors. The bottom will be evidenced by panic. Faith in markets will be lost, and most of these investors, previously indiscriminate buyers, will now not buy at any price. Such a panic was not evident in 2022, and recent indiscriminate buying is not what happens at the bottom, on the contrary.
Knowing all of this is useful in understanding the vulnerability of financial markets, but doesn’t inform us as to the stock market’s precise journey as both the bubble and investor behaviour deflate.
For example, in the 1970s the US and UK stock markets went broadly sideways over a decade, but with gut-wrenching falls after the indices toyed with previous peaks. In prior bear markets, also over the years, an initially sharp fall was followed by a long-winded partial recovery, and then an equally long-winded journey to final lows.
The centre of the bubble and mania is US financial markets, and other markets typically driven by the mood in the US, such as bitcoin and the cryptocurrency universe.
We cannot judge all other financial markets by this US vulnerability. But as the US is globally dominant, it is a cloud over opportunities elsewhere, whether in the UK or across Asia.
There are a range of opportunities:
- Value-style funds around the globe; cheap-to-good value.
- UK stock market, small and medium-sized companies; ditto.
- Japanese smaller companies; ditto.
- China; good value and re-opening opportunity.
- Asia; good value, growing middle classes, China beneficiary.
- Emerging markets; ditto.
- Commodities; lack of supply plus growing long-term demand.
What we do and don’t know:
- We know there are clear opportunities (see above).
- These opportunities are multi-year.
- We do not know how the US financial market deflation will unfold…
- … but we should expect downturns to be very sharp.
Balancing these facts is not easy, and there is no perfect answer, but the following approach has the attraction of simplicity and is supported by a depth and breadth of experience and research:
- Don’t get sucked in by the indiscriminate buying of other investors.
- Drip some money into favoured markets gradually, month by month.
- Retain some cash to reinvest at the (unknown) time when there are notable falls.
- Apply a Stop-Loss rigidly (typically on 10% falls).
These four bullets are an important foundation of our Discretionary Fund Management (DFM) service. In particular, in the world now unfolding we must be able to act quickly, and we can do that with this new discretionary service.
Four Final Points
- We remain cautious of the US and the mountain of global debt, but see opportunities elsewhere.
- This still suggests to us that you should have a decent cash margin in your portfolio.
- If you ever take a different and more immediately optimistic view, and want to take more risk, please do talk to your usual adviser.
- Better still, talk to your usual adviser about our Discretionary Fund Management (DFM) service, which includes all of the above features.
The value of your investments and any income from them can fall as well as rise and past performance is not necessarily a guide to future returns. The value of your investment is not guaranteed and on encashment you may not get back the full amount invested. The illustration uses certain assumed rates of growth, as prescribed by the Financial Conduct Authority. These rates are not guaranteed.