Today’s investment environment is unprecedented and complex – it is easy to feel bullish on Monday, bearish on Tuesday, and have analysis paralysis by Wednesday.
Sitting at our desks in our lockdown offices this time last year, none of us imagined that global stock markets would be at the levels they have now reached. The MSCI World Index, a measure of the world’s largest companies, is up 46% since 30 April 2020.
If you have a naturally conservative disposition, this may emotionally trigger you into believing that the rally cannot continue and may even collapse. If you have a naturally more optimistic disposition, you may feel emboldened and confident for continued gains as the rally continues.
These responses are normal, but they cloud our judgement; great investors recognise their power.
Currently, these are some of the factors we’re seeing that shape investor decisions:
Factors pointing to a likely stock market correction:
- Almost every traditional method of valuing a stock market shows that the king of all stock markets, the S&P 500 in the US, is very expensive relative to historical norms.
- Exuberant behaviour that typically precedes a correction is prevalent. For example, the bitcoin rally (up 5x), the prices of digital art prices (Beeple), the Reddit/GameStop fiasco, the prevalence of SPACs, and the launch of a space exploration fund/ETF by Ark Invest.
- Excessive borrowing to boost returns lead of which Greensill Capital & Archegos Capital Management are prime examples.
Factors pointing to stock market support:
- The adoption of technology and innovation is rapid and impacting every sector of the global economy.
- Central Banks and governments are doing everything to ensure the global recovery stays on track.
- The rollout of vaccines and rising equity markets creates a feel-good wealth effect, which will result in a spending splurge.
- Although the US and Chinese tech stocks have led the global equity market rally, some areas of the equity markets remain historically “cheap”.
- Massive infrastructure spend is coming, which will add a tailwind to economic growth.
Investing Works Best for Cautious Optimists:
Over time, equity markets deliver greater returns than the other traditional asset classes. For this reason alone, an optimistic outlook makes sense. As nobody can predict how equity markets will move over the short term, the best engine for growth and protection of long-term wealth is constant exposure to a properly diversified portfolio of equities, bonds, and cash.
Equity Markets are Expensive:
But valuation does matter, and markets do go through corrections. To defend against this stage of a market cycle, there are other investment tools available:
- Private (unlisted) assets, such as private equity, venture capital or direct property investments. These buffer a portfolio from the volatility of listed investments and provide the opportunity for periods of superior returns.
- Fund strategies that are uncorrelated to listed equities, i.e., they do not go up or down in synch with equity markets – this buffers a portfolio.
- Cash provides options in the event of a sell-off, providing an opportunity to add to a portfolio at lower levels.
In case you were wondering, we are of the more conservative disposition but strive to remain cautiously optimistic.