Miton’s David Jane: Climbing the Wall of Worry

• The current bull market could last longer than investors expect
• Markets are becoming less dependent on central banks
• Repeated market collapses are the exception, not the norm 

David Jane, manager of Miton’s multi-asset fund range, comments:

“It’s a popular pastime among market commentators to worry about the downside. However, little is written about the risk of not participating in market rises and yet that, for long-term investors, is equally important. The vast majority of investors require real capital returns over time as they invest to build their capital over the long-term. An excessively bearish approach risks missing the capital growth, which is the very purpose of making investments in the first place.

“With that in mind, and to counter balance to the slew of negative commentary calling for a correction (defined as a fall of between 5% and 20%) or even a bear market, it’s important to consider the risk of a further substantial leg higher in markets.

“In support of this possibility, there’s one obvious argument: equity markets go up the vast majority of the time and  smaller corrections are much more common than the bigger market crashes. Despite three major setbacks in the last few decades, there have also been extended periods of substantial rises interrupted only by the smaller corrections. It’s human nature to expect the recent past to repeat itself, but a look at longer-term history suggests the repeated pattern of market collapses is the exception, not the norm.

“There are other factor  which support a positive outlook, the most obvious being the strength of the economy worldwide. Growth expectations have been rising, and growth is already strong, while inflation remains under control. This growth is feeding through into company earnings growth, tempering the seemingly high valuations compared to some of recent history.

“These valuations also need to be contextualised in terms of the meagre returns available from the alternatives such as government bonds, index linked securities and corporate bonds. Only real assets such as equity and property appear to be valued similarly to long term norms, whereas all fixed income assets appear to be very richly valued, particularly when inflation and expected inflation are taken into account.

“Equities on the other hand, even at current valuations, offer the prospect of some income growth in line or above inflation and a current dividend yield of around 2% (on the low yielding S&P 500 Index). Arguably, that implies an attractive equity risk premium.

“Another supportive argument is the weight of potential buying. Much attention has been given to the baby boomer generation’s buying of bonds as they near retirement, but this could potentially be highly risky  if inflation remains at current levels or rises. However, this appetite for bonds makes financing costs extremely low for business, particularly those in the buyout space.

“Private equity has been raising record amounts recently and this money needs to be put to work, most likely by buying publicly listed companies, creating a new marginal buyer. There’s a reasonable chance of a spate of takeovers spurring markets on in the coming months, particularly if the buyers think the window of opportunity of financing at ultra-low rates may soon close as central banks continue the slow trajectory of interest rate rises.

“On balance, there are plenty of positive arguments to offset the continuous worries from the pundits, many of whom have been calling for a massive fall right from the start of this long bull market. In fact, the market now looks much less dependent on the artificial support from abnormal central bank policy, and much more driven by genuine profit and revenue growth from a strong global economy.

“Of course, there will be worries about the amount of debt in the world and the effect of interest rate rises on these over-indebted companies. As central bankers are more worried about financial instability than they are about inflation, it’s unlikely that short-term interest rates will be raised aggressively to fight inflation while debt remains an issue.

“As a consequence, we remain constructive on equity, particularly economically sensitive and thematic growth areas, although we continue to temper this by having a low exposure to highly leveraged business and a low overall equity weight relative to history.”

• The current bull market could last longer than investors expect
• Markets are becoming less dependent on central banks
• Repeated market collapses are the exception, not the norm 

David Jane, manager of Miton’s multi-asset fund range, comments:

“It’s a popular pastime among market commentators to worry about the downside. However, little is written about the risk of not participating in market rises and yet that, for long-term investors, is equally important. The vast majority of investors require real capital returns over time as they invest to build their capital over the long-term. An excessively bearish approach risks missing the capital growth, which is the very purpose of making investments in the first place.

“With that in mind, and to counter balance to the slew of negative commentary calling for a correction (defined as a fall of between 5% and 20%) or even a bear market, it’s important to consider the risk of a further substantial leg higher in markets.

“In support of this possibility, there’s one obvious argument: equity markets go up the vast majority of the time and  smaller corrections are much more common than the bigger market crashes. Despite three major setbacks in the last few decades, there have also been extended periods of substantial rises interrupted only by the smaller corrections. It’s human nature to expect the recent past to repeat itself, but a look at longer-term history suggests the repeated pattern of market collapses is the exception, not the norm.

“There are other factor  which support a positive outlook, the most obvious being the strength of the economy worldwide. Growth expectations have been rising, and growth is already strong, while inflation remains under control. This growth is feeding through into company earnings growth, tempering the seemingly high valuations compared to some of recent history.

“These valuations also need to be contextualised in terms of the meagre returns available from the alternatives such as government bonds, index linked securities and corporate bonds. Only real assets such as equity and property appear to be valued similarly to long term norms, whereas all fixed income assets appear to be very richly valued, particularly when inflation and expected inflation are taken into account.

“Equities on the other hand, even at current valuations, offer the prospect of some income growth in line or above inflation and a current dividend yield of around 2% (on the low yielding S&P 500 Index). Arguably, that implies an attractive equity risk premium.

“Another supportive argument is the weight of potential buying. Much attention has been given to the baby boomer generation’s buying of bonds as they near retirement, but this could potentially be highly risky  if inflation remains at current levels or rises. However, this appetite for bonds makes financing costs extremely low for business, particularly those in the buyout space.

“Private equity has been raising record amounts recently and this money needs to be put to work, most likely by buying publicly listed companies, creating a new marginal buyer. There’s a reasonable chance of a spate of takeovers spurring markets on in the coming months, particularly if the buyers think the window of opportunity of financing at ultra-low rates may soon close as central banks continue the slow trajectory of interest rate rises.

“On balance, there are plenty of positive arguments to offset the continuous worries from the pundits, many of whom have been calling for a massive fall right from the start of this long bull market. In fact, the market now looks much less dependent on the artificial support from abnormal central bank policy, and much more driven by genuine profit and revenue growth from a strong global economy.

“Of course, there will be worries about the amount of debt in the world and the effect of interest rate rises on these over-indebted companies. As central bankers are more worried about financial instability than they are about inflation, it’s unlikely that short-term interest rates will be raised aggressively to fight inflation while debt remains an issue.

“As a consequence, we remain constructive on equity, particularly economically sensitive and thematic growth areas, although we continue to temper this by having a low exposure to highly leveraged business and a low overall equity weight relative to history.”