Corrections, bear markets – and Rip Van Winkle

When the mood turns, it can turn fast: barely had investors poured more than $100 billion (£72bn) into global equity markets since the start of the year than the mood changed abruptly.

Last Friday saw the Dow Jones Industrial Average plunge 2.5 per cent to 25,520 – its biggest one day drop in eighteen months. And here the FTSE100 has dropped more than 3 per cent since the start of the year to 7,443. Nearly all major global stock markets were down over the past week. The sell-off has brought to the fore a question that has been tormenting investors for months: might the remarkable nine year bull market be coming to an end?

The sell-off coincided with positive economic news. In the UK the recent strength of sterling on better than expected Q4 growth numbers caused apprehension. But the louder sirens came from the US. January’s US employment report showed non-farm payrolls rose by a larger than expected 200,000, while average hourly earnings rose 0.3 per cent on the month taking the year-on-year increase to a nineyear high of 2.9 per cent.

Great news for Main Street America, buoyed by President Donald Trump’s tax cuts. But the news sparked concerns that inflation – that great spoiler of stock market bull runs – was set for a comeback and that the US Federal Reserve would raise interest rates more aggressively this year than expected. These concerns brought a notable tick-up in US Treasury 10-year bond yields which topped 2.8 per cent for the first time in four years. Now these are still remarkably low levels by historical standards. But it’s the change of expectation on bond yields that matters here.

Ironically, it was – in large part – the expectation that interest rates were likely to be ‘lower for longer’ in pundit parlance that sparked the latest stampede into shares. Analysts at Bank of America Merrill Lynch (BAML) warned that the scale of inflows into stock markets has triggered their contrarian ‘sell’ signal from the group’s ‘bull and bear indicator’, which has accurately signalled a stock market correction 11 times out of 11 since 2002. Ian Kelly, fund manager at investment house Schroders was among the latest to voice his concerns at the level of stock markets, warning the shares hadn’t traded at these levels since the dotcom bubble or just before the Wall Street crash.

Last week I attended an insightful presentation by John Wynn-evans, head of investment strategy at wealth manager Investec. Because of the scorching memory of recent big falls in stock markets – 2001-2003 and 2008-09 – investors are understandably apprehensive about sudden falls in markets. But as Wynn-evans pointed out, there needs to be a set of circumstances for a correction to become a full-blooded bear market. “Bear markets need to be caused by something – for example, a recession. And at present”, he says, “a recession does not look likely”.

Global growth this year looks headed towards four per cent. Emerging markets and China are again doing the heavy lifting. But now the developed economies are also picking up (the UK being the laggard with growth expected at 1.7 per cent). And inflation is likely to remain contained by historical standards. So: a correction looks likely after such a sustained bull run, a full blown bear market much less so.

Rip Van Winkle wins again

Periodically I remind readers of the great investment strategy of Rip Van Winkle: invest, fall asleep and don’t wake up for 20 years. Foolhardy? Latest research from the Association of Investment Companies on the UK Equity Income sector makes wakey-wakey reading for the somnabulant investor.

Data from Morningstar shows that £100,000 invested in the average UK Equity Income investment company on 31 December 1997 would have generated an initial income of £3,831 in 1998 and growing every year to £8,951 in 2017. Over 20 years to 31 December 2017, the investor would have received a total of £125,122 in dividend payments, the average annual divi growth of 4.6 per cent notably higher than the annualised RPI inflation figure of 2.8 per cent. Even assuming investors had spent the income rather than re-invested, the capital value of the £100,000 investment would have doubled to £200,744. Says the Aic’ s anna be l bro die-smith ,“Theuk equity Income investment company sector has not only provided investors with reliable, inflation busting income over 20 years, but also doubled the capital investment after all the income has been taken”.

Such are the rewards of very, very passive investment over 20 years!

A correction looks likely after such a sustained bull run