Recent developments suggest the six year-long bull market in equities is becoming exhausted, according to Jim Wood-Smith, head of research at Hawksmoor, who says investors’ response to Thursday’s interest rate decision is cause for concern.
Though many expected the Federal Reserve to raise interest rates from their historic lows, Janet Yellen announced that they would stay at their rock bottom levels (where they have been sitting for the past six years or due to concerns that the global macroeconomic picture was not showing a clean bill of health and therefore is not strong enough to make progress tighter monetary environment.
Performance of indices since 2009
Source: FE Analytics
While some (such as Royal London’s Trevor Greetham) argue that this is good news for equity investors, the announcement worried the usually bullish Wood-Smith.
He thinks that scrutiny on the macroeconomic picture has reached ‘infatuation’, saying the fixation with when rates will rise is only delaying a greater risk to a sell-off.
“As much as I remain an equity optimist, experience teaches that this is not a healthy state of affairs. A relaxed market would instead be trying to find the next take-over targets, or concentrating on the growth in the eurozone,” Wood-Smith (pictured) said.
“The markets though are far from relaxed, they are as tense as if they were about to make their first appearance on Strictly and haven’t been able to rehearse. As someone who spends too long staring into the macro tea leaves, this feels a little like turkeys and Christmas but the current infatuation with the macro is typical of a tired bull market.”
“The markets are trying to grasp onto reasons why prices should not fall, why the world is ok and why valuations can be justified.”
However, Wood-Smith points out that valuations cannot be justified, which is evidenced by the confirmed future merger of the two largest brewers, AB InBev and SAB Miller last week, one of the largest in history, and how the latter saw its share price jump more than 20 per cent in one day.
Performance of SAB Miller last week
Source: FE Analytics
“A healthy bull market would not care: it would just buy all the global drinks businesses on the assumption that ABI’s lust for SAB means everyone will be taken over. Not this time. In not raising rates, the Fed is actually only making things worse. It is extending the dregs of the current cycle,” he said.
He says The Fed should have acted in last week’s meeting to prevent greater pain further down the line but that because it has not, investors can expect a month or so of high volatility.
“If there really are swelling inflationary pressures, then it needs to raise rates. The longer it goes without doing so, the higher and faster rates will eventually have to move. It is pandering to the markets, trying too hard to avoid upsetting apple conveying vehicles. What is needed is tough love.”
“What happens to the markets now that the Fed has spurned the opportunity to raise American interest rates? Like solitaire, lift-off has been the only game in town.”
“The next meeting of the Federal Open Markets Committee is not until the back end of October; unless the market latches onto something else in the meantime, we are now faced with five weeks of illogical lurches up and down as each piece of data is deemed to make an October rise in the fed funds rate more or less probable.”
While the decision by the Fed is a cause for concern investors will not have to wait much longer to see interest rates start rising for the first time in nine years, says Tom Beckett, chief investment officer at Psigma.
“The reason we feel that the Fed will achieve the necessary confidence levels to boost rates later this year is that China, Dr Yellen's preeminent current concern, should start to see a cyclical economic upswing into the year end.”
“A secondary, but still very important, factor is that the Fed will have seen the negative impact upon asset markets that their decision brought last week and recognise, as we suggested, that putting rates up could actually be a positive confidence boost.”
“Whether the Fed do go or not in December is hard to judge, so we should stick to the fact that US monetary policy is likely to be looser than we had ever imagined and longer term rates are still being massaged lower by the Fed.”
Beckett says while inflation is of little to no concern to most in developed markets today where it has been close to zero for some time, longer term is has the potential to devastate returns from assets.
“I remain fully of the view that uncertainty over inflation later this decade could well surprise on the upside, aided by the insanely loose policy actions of central bankers, delivering a materially nasty shock to complacent investors.”
“Holding cheap inflation break-evens and commodities might well have provided for sleepless nights in the last few years, but could well be the assets to help you sleep in the rest of the decade.”