The market peaked on 26 January this year, according to John Chatfeild-Roberts, head of Jupiter’s multi-manager Merlin team, who said a combination of tightening monetary policy and high valuations means we may be witnessing the start of a bear market.
The general consensus among analysts at the beginning of the year was that the bull run was likely to continue for another 12 months as the market got off to a flying start and the S&P 500 rose by 7.52 per cent in dollar terms in the first 26 days.
However, it then fell 10.12 per cent in less than two weeks with the blame falling on excessive valuations, higher inflation and the threat of a global trade war.
While the S&P 500 is now back in positive territory for the year, Chatfeild-Roberts and the Jupiter Merlin team are doubtful it will return to its 2018 peak in this market cycle.
Performance of indices (in $) year-to-date
Source: FE Analytics
“There are three reasons for this really,” he said. “The continuing rise in interest rates in the US, which we have seen carrying on for some time, the withdrawal of money by the Federal Reserve which is up to $30bn a month at the moment and equally the ECB [European Central Bank] halving its programme by $30bn.
“And the valuation,” he added. “You only have to look at the growth part of the indices to see they are probably overly valued.
“If you look at growth versus value, the differential is roughly where it was in the year 2000. So, for those reasons generally speaking we are positioned for tougher times.”
Jupiter doesn’t have a house view and its managers are free to manage money in the way they wish. However, Ariel Bezalel, who heads up the group’s Strategic Bond fund, said he is definitely more cautious from a fixed income perspective and agrees with Chatfeild-Roberts (pictured) that risk assets have seen their best days.
He also said it was ominous that volatility picked up when the Federal Reserve “tried to take away the punchbowl”.
“Our concern is what we had in February with the big rise in volatility has been a kind of rehearsal for what we are going to see in the second half of this year because that’s when the pace of quantitative tightening – the pace of reduction in the Fed’s balance sheet – really goes into overdrive,” he said.
“And in conjunction with that, they still want to raise rates three times.
“So, we have seen a big pick-up in volatility this year, even though they have only raised rates once and they have only made a slight reduction in their balance sheet. I think it will be difficult for them to raise rates another two-to-three times this year, and another three times next year as well as reducing their balance sheet by another $600bn.”
Bezalel said there are other reasons to be fearful. For example, while the dollar has weakened since the start of 2017, it has rebounded in the past few months and the manager said it is likely to rally further from here – a trend which usually coincides with a slowdown in global growth.
He said this poses problems for emerging markets which he described as a “levered-up play on the US economy” and that the recent rebound has caused “cracks to appear” in the sector.
In particular, Bezalel said he is worried about the impact on countries such as Turkey.
“Turkey has a bit of a current account deficit, political instability and crucially it has a lot of dollar and euro liabilities, especially among corporates which have been borrowing heavily,” he explained.
“The weakness in the Turkish lira is beginning to filter through to other emerging markets such as Mexico and Brazil so you are seeing a bit of contagion going on.
“So the dollar will be crucial and if it continues to rally from here I do fear the cracks could get bigger and bigger in risk assets.”
Bezalel also pointed to the oil price which is up more than 100 per cent since it bottomed out in early 2016, saying it is likely to move higher from here with supply and demand out of balance and Opec “doing its best to juice up the price”.
“The way we think about oil is that it is a tax on the US consumer, it is a tax on world growth,” he continued.
“Typically a $10 rise in the oil price shaves off 0.5 per cent of world GDP. And yet another reason to be cautious is the US consumer accounts for 70 per cent of GDP and this is already weighed down by credit card debt, student loans and mortgage debt and then when you throw the rising price of a tank of gasoline into the mix, it is going to be even tighter.”
Not everyone is so pessimistic about the outlook for the bull run, however. Earlier this month, Mike Bell, global market strategist at JP Morgan Asset Management, pointed out the fall in the US market coincided with a strong upwards revision in earnings, with the result that the market now looks fair value.
“US equities are trading at about 16.5x 12-month forward earnings, which compares with a long-run average since the beginning of 1990 of 15.8x,” he explained.
“These are slightly above that long-run average, but not really stretched. And when you look at the rest of the world, you can see that everywhere else, valuations are below their average since 1990. Because equity markets have gone up a lot since 2009, people are of the opinion that they are expensive. But valuations are cheaper than they were at the beginning of the year.”