This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Wouter Volckaert, an investment manager in the Henderson Global Equities team, examines why so few investors are bullish on equities.
The MSCI All Country World Index is up around 100% since bottoming on March 2009, the FTSE 100 Index is up 90% and many stock market indices are trading near all-time-high levels. We are six years into a bull market rally and by now you would expect to hear your mother-in-law bragging about her latest investment triumphs or to receive hot trading tips from your taxi driver. However, none of this is happening. Some behaviour associates with a mature market cycle: star fund managers are able to raise billions for new funds, merger and acquisition (M&A) activity is picking up, any company seems to be able to raise public money – but stories of newfound riches in the stock market are not reaching us. In fact, this feels like the most unloved bull market I have ever witnessed.
In order to understand the disparity between share price returns and investor sentiment, we need to look at the bull and bear arguments. Let’s start with the positives: Economic data is improving. It’s been a slow recovery since the great recession of 2008 but we are moving in the right direction.
The US is grinding higher and Europe seems to be emerging from its double-dip recession. Some of my colleagues just returned from a meeting with the International Monetary Fund (IMF) in Greece and many will be surprised to hear that Greece is now expected to deliver one of the faster GDP growth rates when compared to Europe.
The 2013 market rally was mainly driven by expanding valuation multiples – ratios used to value a company that describe its financial or operating characteristics. These have run up in recent years. However, if we look to a market with the oldest set of historical data, the Dow Jones Industrial average, we see an interesting picture: this fiscal year, the Price/Earnings (P/E) ratio – that is, the share price relative to a company’s underlying earning - has only just reached its 100-year average, so it seems there’s plenty of room to move higher.
Quantitative easing continues to provide support for company valuations. Tapering of the unprecedented monetary scheme has started in the US, but so far only the amount spent has slowed, it has not yet reversed. Japan is actually stepping up its efforts and Mario Draghi, president of the European Central Bank (ECB), signalled that we could see quantitative easing in Europe too.
Finally, for equity investors, as we get closer to the first interest rate hikes there should be further support for equities as capital moves out of fixed income investments. A large amount of money resides in fixed income products; moving just a fraction could make a big difference.
So with many of the drivers of the six-year rally still in place, why the reservation in investor sentiment?
Fund flows, quantitative easing and expanding valuation multiples are less convincing than a good old economic boom. The wealth of many people has grown on the back of these market drivers, be it from their pension fund, their house, wine collection or vintage car, but it doesn’t feel as sustainable as a 5% GDP growth rate and a frequent big salary increase.
Many realise that we haven’t really tackled any of the problems that caused the 2008 crisis. Debt levels haven’t gone down they’ve just shifted from the consumer to the Government and continue to rise despite the frequent austerity talk. Politicians, in my view, seem more interested in superficial policies that will secure a next term vote rather than much needed reforms. It seems, therefore, that there is very little room to manoeuvre if we were to enter another recession tomorrow.
So longer-term worries have prevented many investors from capturing shorter-term equity returns and the longer the ‘short-term’ lasts, the more painful it gets.
All considered we balance the potential outcomes. On the one hand the market may continue to grind higher for years. The positives are firmly in place and we still meet many companies that offer a good risk/return investment case. On the other hand we are cognisant that the market could turn at any point. With room in valuations for the market to climb higher, we turn our attention to other warning signs: changes in investor sentiment towards quantitative easing and fund flows, or substantially weaker economic data.
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