While there are many factors that could spark a market sell-off, Artemis’ Simon Edelsten argues that investors should be keeping their eyes on three indicators if they want to gauge how likely a full-blown bear market is. 
The sell-off in October has made some investors worry that global markets could be on the brink of more substantial falls, although Edelsten – who co-manages the Artemis Global Select fund and Mid Wynd International Investment Trust – does not think a bear market is imminent.
“When you get a sharp correction, as has taken place in the past few weeks, it's easy to think that it's the beginning of a bear market – and run for the hills,” he said. “But the best thing may be to seize the opportunity to invest more. Fund managers spend a lot of time trying to predict the inflection points for bull and bear markets. Yet it's only with hindsight that you can tell who was right.”
While Edelsten points out that each bear market will have its own signals and triggers, he added that there appears to be “three consistent portents of doom”. Here, we take a look at each.
Slowdown
One of the most consistent warning signs that there is a real risk of a bear market is a significant slowdown in economic growth.
Source: International Monetary Fund’s World Economic Outlook – October 2018
There have been some concerns about the robustness of global growth with several organisations revising down their outlooks. The International Monetary Fund, for example, recently said that growth may have peaked in some major economies and cut its forecasts because of mounting downside risks.
According to an October update to the IMF’s World Economic Outlook, the global economy is now expected to grow by 3.7 per cent in both 2018 and 2019, a downward revision of 20 basis points on the organisation’s July review. Economies such as the US, Europe and emerging Asia have all seen their growth forecasts lowered.
Edelsten said: “While the US economy is likely to slow somewhat from the very strong growth it is enjoying at present, there are no signs of recession. The rest of the world, especially emerging markets and China, are slowing markedly, probably due to US trade disputes and, in some cases, sanctions.
“This seems to be having a knock-on effect on German exports which have been central to European growth in recent years. So, growth is slowing, but that is usually the recipe for a correction, not a bear market.”
Debt
Growing debt levels are another warning of a bear market that should not be ignored. Figures from the Institute of International Finance, published in July, show that global debt had grown to more than $247trn – or 318 per cent of world GDP – by the end of 2018’s first quarter.
Evolution of global debt vs GDP
Source: Bank of America Merrill Lynch
Edelsten pointed out that debt appears to be high but added that the majority of this “is in the best place” – namely, with governments and central banks. Households and large businesses, on the other hand, have tended to avoid loading up on debt since the global financial crisis of 2008.
“One area of debt that has been rising is student loans. This debt reverts to the state if it cannot be paid, but the drag of student loan repayments – currently 9 per cent of salary above £25,000 – and the psychological burden of the total debt figure hanging over 'generation Y' is a significant factor in there having been no consumer upswing for the past decade,” the Artemis Global Select manager continued.
“The end of a consumer upswing often marks the start of a recession. Some may remember the consumer boom just ahead of the crash of 1987 – New Romantic haircuts, post big-bang bubbly, etc. We haven't even started that phase yet.”
Valuations
The valuations of stocks are the final area the Edelsten said can warn of a coming bear market – and this is the one that he is most concerned about.
The decade since the global financial crisis have seen markets embark on a seemingly-unbroken march upwards, with many investors now expressing concern that some areas are looking overvalued. Of course, the sell-off in October has brought valuations down somewhat, but stock markets are still nowhere near as cheap as they once were.
“This is where we see most risk. These have looked on the high side and it's been clear for a while that many investors have fallen madly in love with the disruptive technology stocks whose earnings and growth may no longer match their valuations,” Edelsten said.
However, he noted that the recent correction has eased these concerns somewhat. Indeed, the manager said a review of the stocks that have fallen so that some now look to be “very good value” when their growth potential for 2019 and beyond is taken into account.
An example of this is Facebook. The manager sold his holding in the social network around a year ago on the back of valuation but has recently re-invested in Facebook after it sold off, noting that Instagram and WhatsApp – both now owned by Facebook – continue to grow well.
Performance of indices over 10yrs
Source: FE Analytics
“In a correction it's the overpriced stocks that tumble hardest,” he said. “However, other stocks can get caught up in the panic. We've had some cash held back for a while precisely for this sort of opportunity. We are watching carefully the stocks we would really like to snap up to see which have become over-sold bargains.”
Edelsten has co-managed the £108.7m Artemis Global Select fund with Alex Illingworth and Rosanna Burcheri since its launch in June 2011. Over that time, the four FE Crown-rated fund has made a 137.25 per cent total return, putting in it in the top quartile of the IA Global sector.
The three managers also run the £186.4m Mid Wynd International Investment Trust and have made an 87.45 per cent total return since taking it over in May 2014. This ranks the trust seventh out of the IT Global sector’s 21 members.