The recovery following February’s sell-off is nothing more than a dead cat bounce and there are parallels to be drawn between now and the build-up to 2008’s financial crisis, according to Eoin Murray (pictured). 
The head of investment office at Hermes argues that unusual global monetary policy has lulled investors into a false sense of security while macroeconomic headwinds are continuing to intensify behind the scenes, meaning many investors could be in for a nasty shock.
The start of 2016 was certainly tough for investors, with markets plummeting due to concerns surrounding low commodity prices and China’s growth slowdown.
This came to a head on 11 February when markets endured a material sell-off, with the MSCI AC World falling by almost 10 per cent since the start of the year.
Performance of indices in 2016
Source: FE Analytics
Within the last three months though, markets have broadly recovered due increased dovishness from the Federal Reserve and a slowdown in the strength of the dollar.
While many investors are breathing a sigh of relief and buying into formerly unloved commodity and emerging market holdings (which have now rallied year-to-date), Murray warns that investors should remain wary.
“We’ve had this very odd start to the year, markets took a real dive in February 11 which coincided with that G20 meeting and all of a sudden the oil price started to recover, the dollar started to weaken and suddenly everything is rosy again,” he said.
“I just think all that we’ve seen is the first play of a series of events that we’re going to get throughout the rest of this year prior to getting to a bear market of some sort.”
The head of investment offices points out that the VIX (CBOE Volatility Index) – which is commonly referred to as the ‘fear gauge’ – is at around 15 per cent in the US and Europe, compared to a long-term average of approximately 20 per cent.
He says that this indicates that market risk is lower than a long-term average dating back over 25 years, but he says that this seems “insane” given that we are already 81 months into a market cycle.
“We’re apparently in one of the longest recovery periods on record over the last 50 years given the length of the cycle, yet it doesn’t feel like a recovery,” Murray argued.
“It feels like we’ve limped along without tripping up and smashing our front teeth out. And yet 81 months in, the chances are we’re probably nearing the end of what has been quite an inflated run in bull market equities and we are very possibly rolling over to a bear market.”
He points out that unusual monetary policy from central banks such as the use of quantitative easing and the suppression of interest rates will lead to a lower rate of inflation over the long term and will lead to challenging market conditions over the next few years.
Murray also says that this loose monetary policy cannot continue for much longer – this sentiment was arguably echoed by markets earlier on this year, with the price of gold rallying during 2016 as investors piled into ‘safer’ assets.
Performance of index in 2016
Source: FE Analytics
“QE is effectively borrowing from generations to come to solve our problems today - it doesn’t help and at some point there will have to be a redress,” Murray warned.
“I guess the idea is that if you can boost the economies now you can get back to a growth situation where it will be okay then we’ll be able to pay a lot of this back in the right part of the business cycle, but for me it’s less clear than that.”
“I think that as we see the next evolutions of this unusual monetary policy come out, each time they’re becoming less effective and that to me suggests we’re at the end of this artificial market recovery.”
Another reason that the head of investment office is awaiting the end of a market cycle is because of the situation in China, which he says has been pushed to one side or underestimated by many investors.
While many believe that China’s slowdown will be gradual, Murray warns that a hard landing is becoming increasingly likely and says that reported growth figures coming from China shouldn’t be taken at face value.
“The most recent [growth] number came out at 4.7, that's their official number, bearing in mind when they were still saying six and seven, we mentally took three percentage points off of that and that seems to tie up with a couple of years back when one of the senior officials in the party suggested that they actually couldn't put much credibility behind their own numbers,” he continued.
“If one cared to look at metrics regarding the transport sector or commodities usage and various other productivity measures, you might get closer to a number and, when you do that, there appears to be a 3 per cent discount compared to the official number.”
“That's what most people think is about right and if we're three per cent off of 4.7 we're at 1.7 and that's not too far from zero.”
Another headwind that is worrying Murray that he says is being overlooked by investors is that US earnings growth remains disappointing, despite unemployment rates at a historically low 5.5 per cent.
“2015 was the worst year post-2008 for corporate earnings in the States. We have got a load of problems. The effects of unconventional monetary policy have changed things dramatically which means investors with long term horizons have probably got to scale back their earnings expectations in both equity and fixed income markets,” he warned.
“In 2008 the banks, the ratings agencies and the regulators, who were complacent and possibly asleep on the job, were putting a triple A stamp on absolute rubbish and it was being sold to people who never should have bought them.”
“Is it the same now with central banks, governments and non-conventional monetary policy? Have we been lulled into a false sense of security that everything is going to be rosy and fine? I just don’t think it is. There are certainly interesting parallels to be drawn.”
“This is not to say, however, that there aren’t opportunities for good skilled fund managers to make the right calls and to generate some strong returns.”
