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23rd April 2021
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Market update

Tis the season! For companies to report earnings, that is. The past week has seen many companies report their earnings and investors have been watching closely to try and ascertain whether companies are emerging from the pandemic induced economic paralysis in good shape.

Overall, reporting season is going well with many business, particularly financial institutions reporting earnings well above expectations. However, positive earnings and ongoing good news about easing of lockdown (in the US and UK) haven’t provided much of a tailwind to equities.

After a strong run since November, equities markets hit some weakness early this week and the FTSE 100 fell 2% on Tuesday. As ever, it is hard to pinpoint the exact reason for market weakness although our sense is that it was due to a combination of factors such as crowded positioning in economically sensitive areas of the market, stretched valuations, positive investor sentiment and concerns over a severe new wave of Covid infections on the Indian subcontinent. This would seem to fit with some concerns that higher economic growth expected in the latter part of this year has already been priced in.

Talking of valuation and sentiment, the following two charts show that, taking the S&P 500, the US stock market is as expensive as it was in the DotCom bubble on one measure of value and that sentiment is certainly positive but arguably not stretched by historical standards:

market update g1

In addition, stories of newly minted millionaires who have made fortunes by investing in hitherto niche instruments are being reported more often. Bitcoin, Dogecoin, Gamestop, AMC, Hertz, the list goes on.

We also have the proliferation of SPACs in the US. A SPAC, or Special Purpose Acquisition Company, is a “blank cheque” company which raises capital from investors in order to bring new companies to the stock market without the usual rules and checks involved in the traditional method of an IPO (initial public offering). But here’s the rub. Early investors in SPACs have no idea what the company might invest in. So, not only are there less checks on the company but investors don’t know what they are buying. Call me old fashioned but this doesn’t sound like a great idea.

The latest invention is Non Fungible Tokens, or NFTs. These are based on blockchain technology and allow people to buy or sell items which don’t physically exist, they are virtual. Recent newsworthy examples are Twitter’s CEO, Jack Dorsey, selling the first ever tweet for about £2.1m to a Malaysian businessman. More extreme is the artwork “Everydays: The First 5000 Days,” by the artist going by the name of Beeple, which sold for $69million.

Now, I realise I am in danger of sounding older than my years but, the craze for intangible assets which generate no income and have no physical backing makes little logical sense to me. This combined with increasingly wild, almost daily gyrations in markets feels more and more bubble like in my opinion.

There is a clear danger that investors are lured into these assets having been wooed by heroic stories of traders with little experience making millions in a matter of weeks. As we have previously discussed, Americans are sitting on something like $2 trillion of excess savings, a number which raises to an estimated $5 trillion globally.

Hypothetically, if you were sitting on “free” money from the government might you be tempted to try your hand in one of the get rich quick ideas? After all, who doesn’t want to be an overnight millionaire? I would encourage all to remember that for every story like this, there is one of someone who has lost a significant amount of money as well.

As money (potentially) piles into assets, driving their process ever higher, the spill over to the main markets is hard to judge. One school of thought is that as much money could be chasing returns in the main markets and so retail buyers could provide support to prices. On the other hand, in markets, for every winner there must be a loser. Therefore, much like the Gamestop saga earlier in the year, further mini bubbles could have negative repercussions as the “pros” get nervous over excessive risk taking.

As regular readers will know, our investment philosophy focuses on proper risk management via long term diversification and professional fund selection. This naturally excludes any assets which display extreme volatility or where we simply don’t understand either the asset or return structure. Therefore, you would be right not to expect any direct (some companies hold cryptocurrencies on their balance sheets) investments in Bitcoin, Dogecoin or NFTs in our portfolios. These all “feel” like a short-term gamble rather than a long-term investment and whilst our aversion to higher risk assets may mean returns look relatively pedestrian, we are very comfortable with that. We would much rather deliver steady risk adjusted returns through time instead of being a hero one year and a zero the next.

So, where does this leave us in terms of the outlook? Well, some weakness after such a strong run in markets is, perhaps, to be expected. I have written at length before about inflation and potential of bubbles and, as a reminder, big bubbles don’t just burst by themselves. The economic and monetary backdrop continues to be highly supportive for equites, but we do expect the road to be bumpy. Whist it feels ever more uncomfortable, we would encourage investors to hold their nerve, stick to their long terms plans and keep investing simple.

Until next time, stay well.


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