The recent bout of volatility has been a reminder to investors that stock markets can go down as well as up. For several years, this has been a rarity, with bond and equity markets seeing a near-uninterrupted run for the past decade. However, should the bull market be entering its closing phases, how can investors prepare?
There are a few reasons to be nervous about markets today. As Jason Hollands, managing director at Tilney Investment Services, points out: “growth appears to be moderating, borrowing costs have edged higher, trade disputes are a major source of risk and in the case of the U.S., the effect of tax incentives introduced by the Trump administration to incentivise the repatriation of cash held in overseas subsidiaries is starting to fade."
The latter was a particularly potent factor in fuelling record share buybacks in 2018, proving an important to prop to valuations. It is, therefore, a fair assumption that we are in the later stage of the current bull market, says Hollands.
However, even if the end of the bull market is edging closer, rushing into cash may not be the best plan. Research from RBC shows that investors lose out by, on average, 19% by missing the last six months of a bull market, 29% by missing the last year and 48% by missing the last two years. Markets often have a last hurrah ahead of a downturn.
The type of assets investors should hold in this last leg very much depends on how the bull market is likely to draw to a close. Olly Russ, manager of the Liontrust European Income fund, says: “It depends on what type of bull market it has been, and what has prompted the turn into a bear market – is it valuation driven, as in 2000, or is it more macro-economic, as in 2008?”
Anthony Rayner, co-manager of multi-asset at Miton, agrees that bull markets can have different types of ending - inflationary, recessionary or a systemic risk to the financial systems. This influences what assets might be defined as "risk on" or "risk off". As such, while gold or government bonds are traditionally seen as useful assets in a market downturn, this doesn’t always apply.
Rayner says: "Gold is a ‘risk off’ asset in a deflationary environment, but it may not work in every situation.” Equally, while investors would normally look to developed market government bonds in a downturn, low yields have made that decision more difficult.
Russ says investors need to take a nuanced view, avoiding those sectors where there has been a lot of excitement: “A sign a bull market could be ending is concentration of returns in a few sectors or stocks, rather than a broader market upwards move. But also relevant will be investor concentration in various sectors, and the relevant valuations.
“It is sometimes said bull markets don’t die of old age – there is always some other proximate cause. But usually they are left vulnerable. Usually it would be an excess of some kind building up – of debt, concentration, valuations or corporate exuberance.”
Today, he believes, a number of the growth stocks might look vulnerable: growth has dominated value to an extraordinary extent, so excesses might be seen in the dominance of U.S. large cap tech, and the U.S. earnings story, which has been phenomenal. "That has been aided by buybacks financed by ultra-cheap debt and tax cuts, which is probably not sustainable long-term," he adds.
The Rathbones multi-asset team believes gold has a role to play as a hedge against geopolitical risk. Will McIntosh-Whyte, assistant fund manager on the team, says: “Gold has been recognised as a good option when geopolitical risk is rearing its head.” He is investing in the asset through ETFs.
Rayner believes interest rates are likely to remain lower for longer and investors need to focus on those sectors that benefit: “There is no inflation risk, consumer prices and wages are under control. That argues for defensive equities such as information technology, not the FANGs but areas such as digital payments, good quality growth stocks, even bond proxies.
“U.S. treasuries aren’t a bad thing to hold either. Yields are reasonable and they have good liquidity. Equally, property is likely to benefit from ‘lower for longer’ interest rates.”
Both Rathbones and Rayner stress the importance of liquidity. It is difficult to know when there will be a sell-off, but investors definitely don’t want to be left with a lot of illiquid holdings that they can’t sell when it happens. As such, across asset classes, it is important to stay in areas that are likely to be readily tradeable in a stressed environment. It may not be happening yet, but when it does, it will reward those who are prepared.
