James Swanson, Chief Investment Strategist at MFS turned cautious on global markets earlier this year, but after unexpectedly strong data from Asia, Europe, and the US, he asks if it’s time to change views.
“Based on a steady, broad-based flow of positive reports from around the world, the tide of global economic growth is rising. And as a strategist, I take stands on the markets based on my interpretation of the facts. So, when the facts change, I need to decide whether or not to change my outlook. The facts have definitely changed with the recent news flow.”
Despite a range of positive data, he urges investors to remain cautious, and not get caught up in FOMO (fear of missing out). He gives six reasons that capital preservation is the right way to invest:
- Valuation: Valuation does not determine short-term market returns. To be sure, markets were expensive a year ago and have only gone up. But for long-term investors, entry valuation matters a lot. We have lots of data that show that entering the market when the S&P 500 price/earnings multiple is above 20 — as of 19 October we are at 21 — means that annual returns 10 years down the road tend to lag the return on T-bills, and usually with many more headaches along the way. Right now, most world equity markets are in the richest 10% of their historical valuation range, so it's very hard to find cheap sectors or cheap markets.
- Cycle risk: The US business cycle has entered its ninth year, making it one of the longest cycles ever. The saying goes that business cycles don’t die of old age, but the longer this cycle goes, the higher the odds are of it ending.
- Challenges to global trade flows: Much of the profit accruing to the owners of capital in recent years has been the result of cost savings from global trade. But now, with contentious trade negotiations underway from China to Mexico to Great Britain, it appears clear to me that the world is moving toward less global trade, not more.
- Assets are expensive globally: Other asset categories are expensive too. Bonds in the US, Europe and Japan are all quite rich relative to history, some extremely so. With almost all investment vehicles historically expensive, some investors have gone so far as to speculate in things like cryptocurrencies, such as bitcoin, and the like. That seems unlikely to end well.
- China's wild debt ride: No one is worried about the world's second-biggest economy blowing itself up soon, but China's use of debt, at the state, corporate and personal level, has gotten way above historical norms. At best, this pile of claims could slow growth. At worst, it could trigger a repayment storm. Someday, it could haunt investors.
- Relatively untested instruments: Lastly, I worry about the untested waters of new financial structures. Since the last recession and market downturn, there has been huge growth, measured in trillions of US dollars, in index-tracking vehicles, some of which are highly levered. These new structures have never been truly tested by an influx of sell orders, though the “flash crash” of August 2015 offers a cautionary reminder of what can happen when the herd stampedes for the exits. Spookily, market historians are reliving the events of 30 years ago this week, a market break known as the Great Crash of '87, and one conclusion is clear: Stock market crashes are not caused by fundamentals; they’re caused by panics. Back in 1987, a combination of untested debt-financed risk arbitrage deals and new types of portfolio insurance fueled a collapse in prices that did not coincide with an economic event or recession. We don’t know with any great precision where the hidden fault lines are, but nine years of cheap money and excess cash reserves piling up around the world suggest that financial assets may be vulnerable. Not today and maybe not tomorrow, but someday the tide of money will go back out.
He warns investors that “it haunts me that the later stages of market cycles are often marked by certain repeatable phenomena, such as a rise in day traders, a new “story” that replaces the old story, a fresh sense of confidence that the world of investing has been fixed and, of course, a sense that high market prices are justified. All of these are happening today. Worse, investors are tempted back into risky assets by stories of their neighbours’ big gains, by the fear of missing out."
"Don’t feel left out."
Full article here.