Imagine investing your savings into financial securities that are guaranteed to lose you money. 

Sound strange?

You don’t have to spread your imagination too thinly because that is what is happening across the debt market as you read this. Today there is US$ 12T of negative yielding bonds sloshing around the world. Investors have literally invested US$ 12T into debt securities that are guaranteed to give them less than that in the future if held to maturity. Despite the multi-year bull market, equities still provide an opportunity to make money.

The most common question we are asked is “when will this equity bull market end?

Answering this question starts with defining it. The bull market has been driven by the US market, in particular growth companies. This space is now a highly crowded trade - a strategy we term ‘QAAP’ (Quality at ANY Price). This is explained by low and steady interest rates coupled with insipid GDP growth during the time of a technological/network revolution.

Low interest rates support higher multiples by increasing the present value of future cash flows, which primarily benefits growth stocks. Low GDP growth makes it difficult for mature, old-economy companies to grow encouraging investors to look for growth elsewhere. This growth is being found in disruptors that are benefiting from the technological revolution and network economics, which enables them to harness huge competitive advantages.

A reversal of these factors could be realistic pins for the ‘QAAP’ bubble. However this does not mean the entire market will crash. A highly plausible outcome is that the crash in QAAP bubble will be accompanied by stronger performance in mature, old-economy stocks such as industrials.

What would drive interest rates to increase, GDP growth to accelerate, technological revolution to mature or network economics to be curtailed?

These are broad and complicated questions but we will focus simply on the most obvious.

Clear proponents of rising interest rates include accelerating inflation or increased risk premium. The most obvious source of accelerating inflation is wage growth, which has been stubbornly stagnant despite most economies being at full employment. We expect the tight labour markets will eventually drive up wages, and with it, inflation.

Potential catalysts for increasing risk premium include a major bankruptcy or increased asset price volatility. In 1998, Russia’s default shook the financial markets out of a calm stupor, increasing risk premia around the world and was a key ingredient in the subsequent Asia Crisis and Latam crisis. History may not repeat but it certainly rhymes and analogous events are likely to have a similar impact on risk premia.

GDP growth has been stubbornly muted despite record accommodative monetary policy. With nothing left in that policy tank we think meaningful fiscal stimulus could be the next step. The tax reforms already applied in the US have had a limited lasting impact on GDP growth and we believe a more substantial government policy would be needed to increase spending.

I will not venture into possible drivers of a slowing technological revolution in this article but I will highlight that mega-cap growth companies’ revenue growth clearly decelerated over 2019. Meanwhile, regulation directly aimed at reducing the market power of internet behemoths is expanding virally across the world.

In summary, with equities offering better value than debt, an argument can be made for being close to fully invested in a diversified portfolio of reasonably valued and growing companies. Given the strong potential for a change in equity market leadership, investors should consider holding relatively low exposure to US growth companies, and a meaningful exposure to businesses that benefit from market turbulence (should any of the risks eventuate), as well as to companies that will benefit from fiscal stimulus.  

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