Share price falls: a blip – or start of a bear mar­ket?

The Daily Telegraph - Your Money - - FRONT PAGE -

How can in­vestors de­cide what the stock mar­ket cor­rec­tion means for their port­fo­lios? Richard Evans re­ports

How should in­vestors in­ter­pret the dra­matic events on the world’s stock mar­kets of the past week or so? Amid the flood of fig­ures and com­men­taries, it’s worth keep­ing some ba­sic prin­ci­ples in mind.

Share prices are de­ter­mined by eco­nomic fun­da­men­tals and sen­ti­ment. We’ll re­turn to sen­ti­ment later, but the two key eco­nomic fac­tors that drive stock mar­kets are com­pa­nies’ ex­pected fu­ture prof­its and the re­turns avail­able from other as­sets.

The out­look for cor­po­rate earn­ings is rel­a­tively good, thanks to de­cent and co­or­di­nated eco­nomic growth across the world. But profit growth is not strong enough to jus­tify a con­tin­u­a­tion of the kind of rises in stock mar­kets seen over the past year – ex­cept per­haps in Amer­ica, where Pres­i­dent Trump’s re­cent cut in cor­po­ra­tion tax rates will pro­vide a large boost to com­pa­nies’ prof­itabil­ity.

Put another way, an op­ti­mistic out­look for global growth does not mean that stocks can gain 20pc year af­ter year.

This does not prove that mar­kets are cur­rently over­val­ued (although some val­u­a­tions are much higher than their his­toric norms, as we ex­plain on pages 2 & 3), just that this as­pect of the eco­nomic fun­da­men­tals does not sup­port con­tin­ued rapid share price rises. This is es­pe­cially so when we con­sider the sec­ond as­pect: the re­turns avail­able else­where.

One of the main causes of the bull mar­ket in shares has been cen­tral banks’ pol­icy of low in­ter­est rates and “quan­ti­ta­tive eas­ing”. These pro­grammes sent re­turns on cash and bonds re­spec­tively to rock bot­tom. But the poli­cies are now in re­verse in Amer­ica and some other economies, boost­ing cash sav­ings rates and bond yields. In the US, which sets the tone for all fi­nan­cial mar­kets, yields on twoyear gov­ern­ment bonds have breached the 2pc level, while 10-year bonds yield al­most 3pc.

“Two per cent is the kind of level where savers and in­vestors start to get in­ter­ested again,” said Alasdair McKin­non, man­ager of the Scot­tish In­vest­ment Trust.

On some pre­vi­ous oc­ca­sions, dra­matic falls on Wall Street have prompted Amer­ica’s cen­tral bank, the Fed­eral Re­serve, to de­lay rises in in­ter­est rates in a bid to stem any flow of money away from stocks and into cash or bonds. But it now ap­pears to be con­fi­dent enough about the strength of the econ­omy to let mat­ters take their course.

In other words, in­vestors in Amer­ica, and by ex­ten­sion those else­where, can no longer rely on the Fed­eral Re­serve to come to the res­cue if the stock mar­ket falls.

What about sen­ti­ment? Un­til this cor­rec­tion the US mar­ket had been ris­ing more or less con­sis­tently since the lows of 2009, with some sign of ac­cel­er­a­tion in re­cent months – some­times seen as sig­ni­fy­ing the fi­nal stages of a bull mar­ket. Rises in Bri­tain had been more muted.

All told, the rise and fall do not seem to em­body the kind of dras­tic and sud­den change in at­ti­tude seen, for ex­am­ple, in the burst­ing of the dot­com bub­ble (for more on how mar­kets have be­haved af­ter pre­vi­ous cor­rec­tions, see page 2).

The rise in mar­kets that be­gan in 2009 was some­times called “the most unloved bull mar­ket in his­tory”, which also sug­gests a more equiv­o­cal stance on the part of in­vestors and less scope for a dis­as­trous re­ver­sal in mood. Many in­vestors also kept money in the side­lines in cash, ready to in­vest the mo­ment they scented a bar­gain.

We should also re­mem­ber that stock mar­kets are het­ero­ge­neous beasts and not all stocks rise and fall to­gether. The Tele­graph’s Questor col­umn has re­cently favoured stocks and in­vest­ment trusts that seem able to of­fer strong, non-cycli­cal growth or un­de­mand­ing val­u­a­tions. For four ex­am­ples, see page 3.

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