Bear as I am, the case is there for this bull mar­ket to charge on

The Daily Telegraph - - Business - tom steven­son Tom Steven­son is an in­vest­ment direc­tor at Fi­delity In­ter­na­tional. The views ex­pressed here are his own. He tweets at @tom­steven­son63

Per­haps the most un­help­ful of the psy­cho­log­i­cal flaws we are prone to as in­vestors is con­fir­ma­tion bias. Our de­sire to seek out in­for­ma­tion that re­in­forces our ex­ist­ing be­liefs and to re­ject any­thing that un­der­mines our prej­u­dices is pow­er­ful and dan­ger­ous. As War­ren Buf­fett said: “What the hu­man be­ing is best at do­ing is in­ter­pret­ing all new in­for­ma­tion so that their prior con­clu­sions re­main in­tact.”

We all do it, in all ar­eas of our lives. Cli­mate change, home­opa­thy, the stock mar­ket, Brexit – we all mis­take the de­sire to be right (the com­mend­able search for truth) with the de­sire to have been right, which is of­ten sim­ply the pride that comes be­fore a fall. We cling on to our be­liefs be­cause to en­ter­tain the op­pos­ing ar­gu­ment is cog­ni­tively pain­ful.

In­vestors are par­tic­u­larly vul­ner­a­ble to men­tal short­cuts. They are easy and re­quire lit­tle en­ergy. This is pretty much es­sen­tial in an ac­tiv­ity like in­vest­ment in which the amount of in­for­ma­tion that could be rel­e­vant to our de­ci­sions is in­fi­nite. We ob­vi­ously have to be se­lec­tive in the ideas we use; but we don’t have to, and shouldn’t, pri­ori­tise the data that sim­ply al­lows us to come to the con­clu­sions we want to reach.

If this were the ex­tent of con­fir­ma­tion bias’s cor­ro­sive in­flu­ence on our de­ci­sion-mak­ing it would be bad enough. But, in fact, our de­sire to stick to our prej­u­dices is even more pow­er­ful. Stud­ies have shown that pre­sent­ing counter fac­tual ev­i­dence to a per­son can ac­tu­ally re­in­force their be­liefs. They will emerge not only un­shaken by doubt but even more con­vinced by their ver­sion of re­al­ity and, in some cases, even more evan­gel­i­cal about con­vinc­ing oth­ers of their point of view.

As an in­vestor, one of the things I try to do is to read things that chal­lenge my world view. Even bet­ter is to try to make the case for some­thing I don’t re­ally be­lieve. So, hav­ing spent the past few months shoring up my men­tal de­fences against the on­go­ing bull mar­ket, I have this week gone out in search of rea­sons to be cheer­ful. My de­fault view is “glass half empty”; I’m look­ing for why it might ac­tu­ally be half full.

This is the con­text in which I read the most re­cent of Gold­man Sachs’s ex­cel­lent Top of Mind se­ries of re­ports. The lat­est has an interview with Steve Ein­horn, a for­mer head of re­search at Gold­man and now at New York ad­viser Omega. He thinks the equity bull mar­ket has months, if not years, still to run – per­fect fod­der for a re­luc­tant bull.

Ein­horn’s main as­ser­tion is that this eco­nomic cy­cle re­ally is dif­fer­ent. Hav­ing ex­panded for 101 months, the US eco­nomic up­swing is way longer than the 60 months av­er­age up­turn in the post-war era. It is the sec­ond­longest rally to date and could well end up be­ing the long­est. But long in the tooth does not mean past its sell-by.

The list of rea­sons to ex­pect the econ­omy to con­tinue grow­ing is long. De­spite his­tor­i­cally low un­em­ploy­ment, wage growth is tepid. At the end of the cy­cle it would be over­heat­ing. Eco­nomic out­put re­mains be­low its long-run po­ten­tial and is ris­ing; typ­i­cally, ahead of a re­ces­sion it is above po­ten­tial and fall­ing. Lead­ing eco­nomic in­di­ca­tors usu­ally warn of prob­lems ahead in the months lead­ing up to a re­ces­sion but to­day they are point­ing in the op­po­site di­rec­tion.

Ahead of a down­turn, the Fed Funds in­ter­est rate is usu­ally above the neu­tral rate at which it nei­ther stim­u­lates nor de­presses the econ­omy but to­day it is half as high. The bond yield curve points down in the late stage of the eco­nomic cy­cle, sug­gest­ing fears about fu­ture growth; to­day it is still pos­i­tive. Yes, this is a long eco­nomic cy­cle, but it has also been a no­tably sub­dued one. GDP growth has been well be­low av­er­age in the past eight years. In­fla­tion is unusu­ally muted.

The link be­tween this pro­longed eco­nomic cy­cle and the equity mar­ket is, of course, the Fed­eral Re­serve. The sub­dued re­cov­ery has de­manded an ex­cep­tional re­sponse and the cen­tral bank has de­liv­ered ex­tra­or­di­nary stim­u­lus and near zero in­ter­est rates, and it re­mains ac­com­mo­dat­ing. This mat­ters be­cause, as the adage says, bull mar­kets do not die of old age, they are mur­dered by the Fed. Sup­port­ive mone­tary pol­icy is one of the key rea­sons to ex­pect the party to con­tinue.

Ein­horn iden­ti­fies five bear mar­ket sig­nals that are a pre­req­ui­site for a pro­longed down­turn in share prices as op­posed to a short-term cor­rec­tion (which we may well see). None of the five, he be­lieves, are ring­ing alarm bells.

First, there is no wage in­fla­tion. The kind of earn­ings in­creases that would prompt a re­sponse from the Fed will prob­a­bly not be ev­i­dent be­fore the end of 2019 or 2020. This means the sec­ond bear sig­nal, a hos­tile Fed, is also un­likely for at least a cou­ple of years even if, as ex­pected, Janet Yellen is re­placed. Third, re­ces­sion is un­likely be­fore 2020. Fourth, sen­ti­ment re­mains sub­dued. Fi­nally, val­u­a­tions are not de­mand­ing in an en­vi­ron­ment of per­sis­tently low bond yields.

So, there we are. De­spite the cog­ni­tive dis­so­nance, even we tem­per­a­men­tal bears can make the case for stick­ing with the mar­ket. If you be­lieve the ar­gu­ment then you can also be­lieve the as­so­ci­ated case for share prices ris­ing in line with earn­ings (say 5pc-7pc) with an­other 2pc on top from div­i­dends (closer to 4pc in the UK). The eye sees only what the mind is pre­pared to com­pre­hend so it’s worth open­ing up to the pos­si­bil­ity that we might be wrong.

Some ex­perts think the bull mar­ket could have months, if not years, left to run with none of the clas­sic warn­ing signs yet show­ing

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