This is no time for investors to have all eggs in one basket

At the start of 2018, the consensus was that there’s still reason to be positive about equity markets.

Few, however, expected markets to start the year with so much of a bang. The general view was that the S&P 500 in the US would be up around 10% for the year. It’s already seen more than half of that gain in just over a month.

This is the result of investors moving into equities with an optimism that has not been felt for many years.

Where this is leading?

A number of market watchers have been expressing concerns about how long this bull market has been running, and for how much longer it can continue.

“Last year cemented the 9th year in the current bull market,” says Investec Asset Management’s Ian Cunningham.

“Historically, that is the second longest bull market in the last 100 years. So statistically it’s getting old. But the good news is that bull markets don’t die of old age.”

Valuations have become more expensive, but that doesn’t mean they can’t still move higher. Investors have to look at other things as well. “The fundamentals remain supportive. The global economic environment has improved and corporate earnings are phenomenally strong.”

So for now, there’s still reason to be bullish. However, he has begun to position his funds more defensively, as there are some “red flags” that shouldn’t be ignored. Signs of euphoria “Investors have become more fully positioned in equity markets, and there are some signs of euphoria,” Cunningham says.

“Typically when you look at bull markets through history, you have a period … when they are unloved and climbing a wall of worry, but as you get towards the latter stages people become more enthusiastic and areas of the market make exponential type gains.

“When we look at things now, we see similar signs. Money is flowing into anything related to artificial intelligence or automation, and we all know what cryptocurrencies are doing.” Quantitative tightening Another reason for investors to be cautious is that quantitative easing by central banks around the world is reaching its end.

A natural consequence of having more money in a system where there are a finite number of assets is that prices will go up. This is exactly what has happened in equity markets. Investors must therefore consider what will happen when this liquidity starts being withdrawn.

“Almost all bear markets are caused by a material increase of the cost of capital – in other words, interest rates rising,” says Cunningham. “These are clouds on the horizon that we need to monitor closely.”

These factors don’t mean a market downturn is imminent, but there’s reason for investors to be cautious.

“There are times to allocate capital to risk, and times to diversify and be more defensive. The current point is not the time to be highly concentrated and have all your eggs in one basket. We believe it’s time to take some chips off the table.”