At the recent Jupiter annual dinner, two fund managers debated whether the markets peaked on 26 January.
- Stock and bond markets are facing tougher times and the risk/reward appears asymmetric from here
- Cracks are appearing in the form of weaker retail spending and corporate bankruptcies
- However, the real risks may be elsewhere
While both sides had merit, the debate was more whether stocks could have a last hurrah than whether they move into a sustainable growth pattern from here.
There are some clear negatives: the withdrawal of monetary support from the Federal Reserve. Interest rates continue to rise, probably another twice in 2018 and another three times in 2019. Valuations remain high compared to historic averages, and the gap between growth and value is the widest it has been since 2000. Their conclusion? “We are positioned for tougher times”.
Even the manager who argued that markets may not have peaked admitted that the risk and reward was now asymmetric, and that some cracks were beginning to appear.
Within UK markets, these cracks are now being seen in rising bankruptcies among some of the smaller cap names. This is particularly prevalent within certain vulnerable sectors – government outsourcing and retail for example. Statistics from BNY Mellon show that there had been 11 retail failures by the end of February. For context, that puts 2018 on course to be worse than both 2008 and 2012. This is on top of 44 failures in 2017.
What can investors do about this? With precious few ‘safe havens’ left, it’s difficult to know where to hide. Jupiter’s Ben Whitmore argues that, in fact, value is starting to emerge. The UK has been very, very unpopular and that has helped keep valuations in check in a way that hasn’t happened elsewhere. There are vulnerabilities among the retailers, but those with strong, flexible business models can and will survive. At the same time, it’s not like investors don’t know that the UK consumer is in trouble.
Equally, the UK consumer is about to receive a small boost, with wages rising higher than inflation for the first time in over a year. That puts more money in their pockets and may help save the beleaguered retail sector.
If anything, there are greater risks elsewhere. That includes the prospect of higher inflation in the US – which would prompt rapid rate rises – or wider disillusionment with the concept of capitalism altogether and its ability to generate wealth for many people.
The cracks are certainly starting to appear, but the ones that become problematic may not be the ones we see today. Either way, ‘positioning for tougher times’ seems a sensible approach.