New article from Tatton Investment Management: Steady markets vs. noisy politics

24 August 2018

Following last week’s upheaval over Turkey’s currency nosedive, this week proved remarkably calm in markets. There was a broad recovery and the US’ S&P 500 stock market index even hit an all-time high on Friday, which supposedly also now constitutes the longest bull market period. This had financial commentators around the world excited and musing about the probabilities that this long period would have to come to an end very soon – simply because of historical precedence.

I was therefore grateful that John Authers’ from the Financial Times pointed out that the length of previous bull markets had perhaps been somewhat arbitrarily defined by simply looking at the last time the market index fell 20% peak to trough as a starting point. Setting the starting point for the last prolonged bull market – which ended in 2000 when the dot-com bubble deflated – is ambiguous by that measure, because the S&P500 fell only very nearly 20% in 1990 after Saddam Hussein invaded Kuwait. It certainly fell the full 20% in 1987 (even in one day), which would mean that the current bull market has at least another 4 years before it breaks that record.

But even that does feel somewhat arbitrary, given the 2000 and 2007 market peaks where followed by far longer market downturns, which were driven by significant economic downturns. Both the 1987 and 1990 crashes were ultimately just severe corrections (1987 closed with markets higher than they had started and the 1990 recovery took not even 6 months). Crucially, they were not accompanied by particular economic downturns. We have to go back to 1982 to find a starting point that originates from a suitably depressed outset in both the markets and economy. As John Authers’ chart below shows, this would make the fourfold increase in the value of the US stock market since the depth of the Financial Crisis in 2009 seem almost insignificant. I am not for a minute suggesting that history will exactly repeat itself. However, I do believe that these observations demonstrate, how little value the siren calls of this past week carry.

Back to the real world. Let’s look at the various economic data releases of the week. For us, the more notable insight derived of a chart is discussed in our article ‘Regional surprise’ which shows that, in terms of positive economic surprises, Europe has now overtaken the US, which has begun to slow in this regard – just like China. This observation, paired with the much more elevated relative valuations of US stocks, is most likely the reason why we are beginning to read from an increasing number of investment research sources that they expect not only economic growth leadership, but also stock market return leadership to pass from the US to Europe and Japan.

On that basis, the UK should be expected to storm ahead. UK valuations are some of the lowest around the western world and positive economic surprises at the highest. Alas, Thursday’s release of the government’s business guidance for a no-deal Brexit scenario brought home to everybody what is holding back the UK at the moment. Still not knowing whether to prepare for a significant change in our terms of trade with our largest trading partners next year in March is creating a significant dampener for all other medium-term business plans. Any form of change always brings about opportunities as well and they might indeed even outweigh the initial costs of adjustment. But they are just as uncertain at the moment as the final outcome of the Brexit divorce process. Calling preparations for and assessments of the costs for a UK outside a customs union is a rehash of ‘project fear’. It’s irrational and demonstrates just how little some of the staunchest Brexit proponents really care about the welfare of their fellow citizens.

We would agree with the government that the likelihood of a total no-deal exit next March is very slim. But as we have written here before, it is quite likely that the period of uncertainty for British businesses will stretch far beyond March 2019. The economic drag this will create is in our opinion by now more than priced in to UK stock markets. But the economic upside we are experiencing (despite the prevailing uncertain conditions - as we can read from the current up trending data flow) has yet to materialise in capital valuations. The pleasing flip side of this situation is, once again, attractive dividend yield levels for investors in the UK stock market.

We will leave the US political news around Trump’s legal battles to the cartoon at the top, because we cannot see much basis for an impeachment by his own Republican Majority Congress. Should he lose the majority in the House of Representatives in November’s Midterm elections then this might change, but even then, the Democrats will have to think twice whether to risk seeing the impeachment process stall in the Senate, as it did with Bill Clinton and arguably rallied support around him for his re-election.

If the level-headed politicians prevail, then judging President Trump will be left to the US electorate, rather than the courts. The relative calm of stock markets tells us that the ‘wisdom of the masses’ represented in capital market action, sees it similar.

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