Irrational exuberance is one of the key indications that the end of a bull market is nigh – but it is fund management firms rather than investors who are getting carried away.
A couple of years of calm conditions for equity markets was brought to an abrupt halt in the final quarter of 2018, leading more bearish commentators to argue the nine-year bull market had finally run its course.
As ever, time will tell whether the falls are a wobble or a sign of a more pronounced correction to come, but one ominous sign is that 2018 was a record-breaking year for exchange traded fund (ETF) launches. According to number-crunching by the Financial Times, a total of 323 ETFs listed on the London Stock Exchange in 2018, almost double the 177 that listed in 2017.
The chart-topping number of ETF launches in 2018 coincides with one of the longest bull markets on record. It is therefore arguably a signal that the bull market is in its latter stages, given that ‘irrational exuberance’ is one of the key indications the end of a bull market is nigh.
The tech bubble at the turn of the millennium a case in point. Various fund management firms scrambled to launch tech funds at the height of the bubble, and investors handed over their cash.
This time around fund, firms are racing to launch ETFs – and investors are buying, with Morningstar, the data company, noting that £3 billion was invested in UK equity ETFs in October and November. In contrast, active funds have fell out of favour, with £2.1 billion withdrawn in November alone across all fund types.
But, while irrational exuberance is one danger sign worth looking out for, it is not the main characteristic of the 10 biggest bear markets since the Wall Street crash in 1929.
According to research by JP Morgan Asset Management, in eight occasions out of 10 it was a recession that tipped stockmarkets over the edge.
Other danger signs to watch out for are extreme valuations and premature policy tightening, in other words interest rates rising too fast, too soon, and negatively impacting an economy.
The positive here is that a recession does not appear to be on the cards, according to Trevor Greetham, head of multi-asset at Royal London Asset Management. Greetham points out that although we are late in the business cycle and volatility is likely to remain high, “markets are premature to be pricing in a US recession.”
He adds: “The US labour market remains strong, fiscal policy is loose and the US Federal Reserve is close to pausing its rate hikes. Housing weakness is a concern but a sharply lower oil price should boost US consumer spending in 2019.”
Moreover, although investors have been chasing the last throes, potentially, of the longest and perhaps most unloved bull market in history, the increasing popularity of passive funds comes against a backdrop of growing scepticism over active funds’ ability to add value.