In­vest DIY: What goes up must come down…

The US mar­ket is ex­pe­ri­enc­ing its long­est-ever bull run. But this will even­tu­ally come to an end, af­fect­ing South African in­vestors sig­nif­i­cantly.

Finweek English Edition - - Contents - By Si­mon Brown

the US mar­kets re­cently hit a long­est-run­ning bull mar­ket ever as the mar­kets had not ex­pe­ri­enced a sin­gle drop of more than 20% since March 2009 (when this run started). That is an amaz­ing stat. JSE in­vestors have seen lit­tle of this. Over the last four years, our mar­ket has added only about 10% in to­tal, and is there­fore sig­nif­i­cantly lag­ging the US mar­kets.

But it is very im­por­tant to re­mem­ber that, much like ev­ery bear mar­ket is fol­lowed by a bull mar­ket, so it is true that ev­ery bull mar­ket is fol­lowed by a bear mar­ket.

So, these data points raise two ques­tions. When will the US bull mar­ket end? And sec­ondly, what hap­pens if it ends sooner rather than later? What if it takes us down with it, leav­ing lo­cal in­vestors in a bear mar­ket with­out hav­ing had the cor­re­spond­ing bull mar­ket be­fore­hand?

The an­swer to the sec­ond ques­tion is easy: It cer­tainly is a dis­tinct pos­si­bil­ity and would frankly be nasty. Very nasty. But there is not much we can do about it, as US mar­kets do lead the world. No mar­ket can es­cape a US bear.

Fur­ther­more, the cur­rent jit­ters in emerg­ing mar­kets could send us into a bear, deny­ing us our full bull mar­ket quota. The ques­tion on when the cur­rent US bull mar­ket will end, is a to­tal un­known. But we do have a sense of what typ­i­cally kills a bull mar­ket – high in­ter­est rates.

Here, ex­actly which in­ter­est rates are rel­e­vant, is open to de­bate. But the gen­eral view is that the US 10-year trea­sury bonds are a good in­di­ca­tion, and they’re cur­rently just be­low 3%. The of­ten­men­tioned magic num­ber to be scared of is around 4.5%. We do there­fore still have a way to go, but rates can move quickly. And, of course, some­thing could come from left field and make mar­kets weaker.

While the next bear mar­ket is def­i­nitely com­ing, it’s just the when that we have no idea about.

There are many rea­sons why eq­uity in­vestors fear higher rates. These in­clude that it trans­lates into higher cost of debt for com­pa­nies; that in­vestors are able to get de­cent risk-free re­turns by sit­ting in cash or govern­ment debt; and fi­nally, that higher rates push val­u­a­tions down when us­ing the higher rate as the risk-free com­po­nent in val­u­a­tions.

Watch­ing the US 10-year rates, there are a num­ber of is­sues that could drive it higher. Mostly, how­ever, it boils down to ris­ing in­fla­tion that sends the Fed­eral Re­serve rate higher – a cy­cle that has al­ready started.

In­fla­tion has been very be­nign in the US, but we are see­ing some signs of it slowly start­ing to come back, with the most re­cent data show­ing wage growth in­fla­tion spik­ing. This is an im­por­tant num­ber to watch as wage in­fla­tion leads to ei­ther higher prices at the store or smaller mar­gins if com­pa­nies try to ab­sorb the in­fla­tion. That wage growth will also see work­ers spend­ing that ex­tra money, lead­ing to over­all con­sumer in­fla­tion ris­ing. This could send the Fed rate higher, which will re­sult in a higher 10-year rate, and hence the end of a bull mar­ket.

While the next bear mar­ket is def­i­nitely com­ing, it’s just the when that we have no idea about. It could be start­ing as you’re reading this, or it could be years away.

An­other im­por­tant point is a mar­ket crash as op­posed to a cor­rec­tion. The dif­fer­ence be­tween a mar­ket crash and a cor­rec­tion is the speed and size of the sell­off. A crash hap­pens from an over­sold po­si­tion. An over­sold po­si­tion is a tech­ni­cal term, but es­sen­tially means that mar­kets would al­ready have sold off and be markedly weaker. Buy­ers then ca­pit­u­late and turn into sell­ers – and that’s when you see a crash.

Will this bull end in a bear or in a crash? And when will this hap­pen? I have no clue, but as al­ways, wor­ry­ing about it doesn’t help. Own qual­ity stocks and know what’ll make you sell. And keep buy­ing your ex­change-traded funds re­gard­less. ■ ed­i­to­rial@fin­week.co.za

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