James Horniman, portfolio manager at James Hambro & Partners, debates whether the bull is dying or just catching its breath.
'Bull markets very seldom die of old age, rather they are killed off by central bankers going too far in their attempts to prevent economies from overheating.
Sustained growth and inflation have been limited since the recovery began in 2009. However, over the past two years, major economies around the world have seen synchronised global growth and a return of inflationary pressures.
The US economy, which tends to lead the way for the rest of the world, has seen unemployment fall from 10% in 2009 to 4% today; there is real concern that higher consumer confidence and higher wages will drive higher inflation.
Central banks tasked with controlling inflation look set to continue their rate-raising agenda, with the Federal Reserve raising the base rate a further 25bps to 1.75% last week.
The consequences of rates being lifted too high can easily shift the economy from what was once a self-fulfilling cycle of positivity – falling unemployment, rising wages and increased confidence – into a negative spiral of falling confidence characterised by reduced investment, rising unemployment and eventually a recession.
The concern of markets is that the challenge of creating the fabled ‘Goldilocks economy’ scenario – neither too hot nor too cold – is too great for the central banks.
Investors are mindful of other threats beyond how sharply the central banks raise rates, in particular, protectionism and potential trade wars incited by the Trump administration.
History has taught us that in the two trade wars of the last 25 years, US tariffs had a more material impact on financial assets than economies, with equities and the dollar falling while gold, the euro and yen rallied.
Although bond yields are showing signs of rising, with the 10-year US Treasury climbing from 1.35% in mid 2016 to near 2.8%, we still feel equities provide the best risk-adjusted return for investors. This is especially true in an environment like today’s, as company earnings revisions are still positive and well-run businesses are able to pass on the effects of inflation.
Economic growth signals remain positive but we are aware market risks have risen and asset prices in both bonds and equities are high relative to historical levels. It is at these moments that our thesis on each underlying asset/company and our selection of each fund manager we deploy capital to must be tested most rigorously and our conviction assured.
If our conviction is lacking at this moment in the cycle, it is better to hold more cash and wait for the dust to settle. We raised our cash levels at the beginning of the year and through a diversified portfolio that includes property, gold and absolute return funds in addition to bond and equity exposure, we feel well prepared for either outcome – the bull dying or simply pausing to catch its breath before resuming the charge.'