Only 33 per cent of FE Trustnet readers believe there isn’t going to a significant equity market correction in the remaining months of 2016, according to our latest poll. .jpg)
Following a significant rally in equities (and nearly all other asset classes) since the UK voted to leave the EU in late June, we asked investors whether or not they were expecting a crash in risk assets over the short term.
It seems that our readers aren’t raging bulls at this point in time, as while 25 per cent said they had no idea what the next few months will hold, some 42 per cent of the 2,032 of you who voted were expecting a painful correction.
Certainly, it’s easy to see why many are feeling cautious.
Despite all the doom and gloom earlier in the year and the fact Brexit was supposed to be bad news for equities, the MSCI AC World index has returned 18.56 per cent in sterling terms since the start of the year and 15 per cent since the referendum itself.
Performance of index in 2016
Source: FE Analytics
That means global equities have now risen 196.61 per cent since the global financial crisis – which was the last time the index posted a drawdown of more than 20 per cent.
Reasons for the Brexit rally have been well-documented, with sterling weakness aiding returns for UK investors and benefitting the FTSE’s large proportion of international earners, while added liquidity from the Bank of England has forced risk assets higher during a period of thinner trading volumes (as is normally the case during the late summer).
The causes for concern, therefore, are that this rally is not built on sound fundamentals – just a continuation of looser and looser monetary policy from central banks which has done very little for the real economy.
The economic and political backdrop has arguably worsened thanks to vote, yet valuations have risen and (using the VIX index) volatility has dropped to levels that many believe shows complacency is rife.
Throw in the fact the US presidential election, which is looking very difficult to call, will soon be upon us, it is no surprise the average UK equity manager has decided to up cash levels.
Mike Deverell, investment manager at Equilibrium, says that while short-term market moves are impossible to call readers are right to prepare for a market shake-up.
“I’m not going to call a major correction, but equities look pretty expensive right now,” Deverell said.
“The P/E on the UK market is up to nearly 20 times, compared to its long-term average of 14 times. I’m not saying there is going to be a crash, so to speak, but there is quite a strong correlation between higher than average valuations and lower than average returns.”
This sense of pessimism towards risk assets has been borne out in recent fund flow data from the Investment Association.
The headline figures from the trade body initially look promising as the data shows that funds under management in the IA universe are nearing record highs thanks to declining levels of outflows after the Brexit vote.
What’s more interesting, however, is that while outflows at a headline level have slowed-down, the large majority of inflows are going into very defensive sectors.
The five best-selling Investment sectors in July 2016
Source: FE Analytics
Indeed, the best-selling sector in July was IA Targeted Absolute Return with net retail sales of £464m. Making up the rest of the most popular peer groups last month were IA Sterling Corporate Bond, IA Short Term Money Market, IA Sterling Strategic Bond and IA Global Bond.
On the other hand, equity funds witnessed a £2.2bn outflow with the IA UK All Companies sector being hit by net outflows of £917m last month.
In relation to the figures, Tilney Bestinvest’s Jason Hollands said: “While fears of a Brexit-induced meltdown have abated, there are however other reasons to be cautious.”
“Concerns around the scale of China’s credit bubble have not gone away, markets want greater clarity on the direction of US monetary policy and US elections will increasingly coming into focus when the televised debates begin in late September. But above all, asset prices look pretty expensive at a time when the outlook for global growth is far from bullish.”
Rob Morgan, pensions and investment analyst at Charles Stanley Direct, says it is very understandable why investors are bearish – especially as seemingly all asset class have risen together since late June.
“I am slightly nervous as virtually everything has risen post the Brexit vote, with the odd exception that includes direct property funds and a few absolute return funds that got things wrong. This level of correlation, and lack of volatility, makes me uneasy as if everything goes up in unison it may well reverse in unison too,” Morgan said.
According to FE data, apart from property funds – which were hit by a liquidity mismatch and asset write downs following the vote, meaning many had to change their pricing or suspend trading – the likes of equities, government bonds, investment grade corporate bonds, high yield bonds and gold have made decent returns since the referendum.
Performance of asset classes since EU referendum
Source: FE Analytics
As such, Deverell is keeping money out of the market for the time being.
“We are underweight equities, though not massively, but we do have quite a lot of cash in the portfolios as having seen the market move strongly upwards over a short space of time, there is always the risk it will move downwards quickly – so we want the ability to take advantage of lower prices,” he said.
“However, we are basically underweight everything at the moment given the moves we have seen.”
While there are those who believe this market is heading towards a disastrous end – such as City Financial’s Peter Toogood, who recently told FE Trustnet that the upcoming crisis will make 2008 “look like a picnic” – Morgan says investors need to be pragmatic.
“However, I also find it hard to be too bearish,” Morgan said.
“Sterling weakness has been propelling many sectors including equities, which partly explains the correlation, plus yield is one of the primary drivers of markets right now and equities remain the place to find it – if you sell how are you going to replace your income stream?
“Certainly not with cash or investment grade bonds. I think this yield compression trend could have a bit further to run, which essentially means keeping invested even if it might seem rather uncomfortable.”
Average yield across IA sectors
Source: FE Analytics
“The big risks of course are central bank tightening, notably in the US (but I don’t see this happening in the run up to the presidential election) and how the market might react to a Trump victory – a distinct possibility and an unknown quantity.”
“I would be minded to use any market dips as an opportunity to top up, or otherwise stay invested in risk assets and ride out the volatility.”
His thoughts are echoed by Hargreaves Lansdown’s Laith Khalaf, who says the recent selling of equity funds – as highlighted by data from the IA – could actually be a net benefit for the market.
“While large sums have clearly been withdrawn from equity funds, the yields on offer from bonds and cash are pretty crummy right now, and for long-term investors the stock market at least gives them a fighting chance of beating inflation,” he said.
