American writer Mark Twain once noted that ‘history does not repeat itself, but it often rhymes’, and when it comes to the stock market there are certain trends and patterns that are worth keeping an eye on. While one of the oldest adages in town, ‘sell in May’, has arguably become outdated, seasonality does exist in other forms.
For example, there are certain shares that tend to consistently outperform in the winter months. In the case of stock market crashes, so-called ‘black swan’ events can take everyone by surprise; but there are certain ‘danger signs’ worth looking for. According to Brain Dennehy of fund analyst Fundexpert, as the 30th anniversary of Black Monday approaches there are certain parallels that can be drawn between 1987 and 2017.
‘The essential foundation for a crash was laid by the market running too far too fast – it’s that simple. By August 1987 the FTSE 100 index was running 30 per cent above the long-term trend (the 200-day moving average). Right now, it is almost exactly at the level of the long-term trend.’
Dennehy argues that today markets are expensive, but this does not necessarily mean a crash is around the corner as stock markets can stay overvalued for years, continuing to become more expensive.
He adds: ‘The market vulnerability now is quite different from 1987, and is derived from the most expensive US stock market ever. This is accompanied by widespread investor irrationality: the scale of ETF buying with a focus on price, and a reckless disregard of value. Together these two elements are the foundation for a classic investment bubble.’
According to research by JP Morgan Asset Management, which looked at common characteristics of the 10 biggest bear markets since the Wall Street crash in 1929, extreme valuations do not singlehandedly tend to cause a market meltdown. On eight occasions out of the 10, as the chart below shows, a recession was the final straw that tipped stock markets over the edge.
According to Eoin Murray, head of investment at Hermes Investment Management, there’s another reason why markets do not look ripe for a fall. Irrational exuberance, common during other stock market purple patches, has been noticeably lacking. Indeed, there’s been a shortage of taxi drivers offering share tips – in London at least.
‘There are still plenty of bears around – and we really should expect them to capitulate before we have truly entered the death throes of this run,’ comments Murray.
Another positive is that interest rate rises are expected to be slow and gradual, notes Trevor Greetham, head of multi asset at Royal London Asset Management. Previous bull markets have ground to a halt following aggressive increases in interest rates.
Greetham is in the camp that maintains the current eight-year long bull market won’t simply fade away.
‘Stock prices have been rising for more than eight years but bull markets don’t die of old age. There are few signs of the excessive growth, excessive valuation or excessive financial leverage that usually signal the approach of a bear market,’ he says.
‘The world economy is picking up but wage inflation remains muted, despite low unemployment rates. Central banks are reluctant to tighten policy in a meaningful way. With interest rates well below the rate of inflation, it’s not surprising that money continues to flow into markets.’
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