Bullish sentiment dominates the market after the economic news for the UK and the US has started to improve.
However, Lyon (pictured) says that asset prices are becoming divorced from reality and investors are paying more and more for equities displaying no earnings growth.The inevitable result will be another bubble and an eventual burst.
“Earnings need to increase sharply to provide rational justification for current valuations of most stocks and markets,” Lyon said.
“If they do not and positive market momentum continues, then equity markets are at risk of entering another bubble while the echoes of the last two popping are still in earshot.”
“Stock market bubbles are very democratic; they make all investors look foolish either before or after the peak. We will always be lonely and choose the former.”
The growth of the broader equity market has stalled over the past couple of months, but smaller companies and technology stocks in particular have continued to rise.
Performance of indices over 1yr
Source: FE Analytics
Lyon adds his voice to those experts warning that this dynamic is reminiscent of the tech bubble of the early 2000s.
“With the exception of a few selective opportunities, overall stock market valuations look anything but mouth-watering and recent parabolic surges in the social media stocks and the biotech sector are reminiscent of the tech bubble in 1999.”
“We will be consistent in our investment approach and not be tempted into such areas. This is a time in the cycle where careless capital will, ultimately, be lost.”
“Today it is difficult to recall another time in the recent past when optimism about the stock market, profits and the UK economy was so widespread.”
“Fear has unquestionably surrendered to greed and stock markets, to us, look more expensive and more extended that at any time since 2007.”
“Investor faith in central bankers is at an all-time high. Many stocks are trading on, in our opinion, nose-bleed valuations, yet investors seem happy to go tripping along a high tightrope in the belief that the Federal Reserve stands ready with a safety net, not near the floor but only inches below the rope.”
“This explains why stock market corrections have become both shallower and more infrequent. With interest rates already at zero, this safety net may be more illusionary than real.”
“We see risk when others are blind to it and refuse to chase returns just because we have recently underperformed.”
The £567m Personal Assets Trust targets capital preservation and then an absolute return with risk below that of the All Share.
The fund has struggled over the past year and is now behind the returns of the FTSE and its peers in the global growth sector over three years, too.
Performance of trust vs sector and index over 3yrs
Source: FE Analytics
Lyon says that the market conditions have made it very difficult to find defensive assets, which is forcing cautiously minded investors to take on more risk than they would like.
“Universally low yields have been a painful thorn in our side for the past two years,” he said.
“At the start of 2012 we wrote about how we believed that it would be harder for us to generate good returns, given that yields across most assets had significantly compressed.”
“That warning was timely and frustratingly accurate. Our caution on equities came too early. Not holding more in equities these last 12 months was a blow on the chin, but holding alternatives that demonstrated a negative correlation to rising stocks has been a more painful punch to the stomach.”
“In 2000 and 2007, opportunities were available for the canny to protect capital. In 2000, it was in so-called 'old economy' stocks that had been left behind in the unseemly dash for internet stocks.”
“In 2007 bonds offered protection along with foreign currency as sterling was extremely overvalued. Today, all those routes of escape are more dangerous.”
“Furthermore, traditional safe-haven assets such as gold and index-linked bonds have recently been anything but safe. Trying to act prudently has been punished. Since the summer of 2012 it has, surprisingly to us, paid to be bullish.”
“Developed world stock markets have been driven more by the fumes of hope than the fuel of impressive earnings growth.”
“Indeed, the overwhelming majority of last year's US stock market progress came from multiple expansion rather than an improvement in corporate fundamentals.”
“In both the UK and continental Europe, earnings in 2013 are likely to have fallen for a second consecutive year, meaning that all of the impressive advances were predicated on investors' willingness to pay more for less.”
The manager says that he is sticking to the blue chip equities that he trusts even as the rest of the market becomes frothy.
“Within this environment, as patient investors with an eye on value, we have found new investment opportunities to be few and far between.”
“A number of our favoured stocks have been de-rated recently, in part due to currency-led earnings downgrades, which we view as temporary.”
“This may begin to provide opportunities to increase our holdings in equities at the margin. We prefer buying when sentiment is soured and so we took the opportunity of share price weakness to add to our core holdings of Dr Pepper Snapple Group and Philip Morris International.”
