Market Update

In our last commentary we wrote about the historical tendency of equity markets to experience, on average, their first reversal of the year during May. While there were certainly down days during May, investors abiding by the folkloric advice to “sell in May” would have been disappointed to see global equities continue to reach new peaks.

We can observe from history that markets move in fairly distinct phases, with a tendency to discount the economic cycle well before it is visible in official data. Thus, risk assets, such as equities and corporate bonds, troughed in mid-March 2020, before the majority of the world’s population had even entered its first lockdown. By the same token, the peak will be reached long before we can identify any sort of downturn emerging in the numbers.

Strategists at Goldman Sachs split the lifespan of the equity market cycle into four phases: Despair, Hope, Growth and Optimism. Despair, quite clearly, perfectly describes the violent sell-off that was the reaction to the dawning nightmare of COVID last year. However, already proving, perhaps, that not all cycles are the same, this period of despair lasted just a few weeks, as opposed to the average of sixteen months (across all cycles since 1973).

Next comes Hope. During this phase earnings expectations continue to fall, but investors begin to anticipate recovery, and apply a (much) higher multiple to those earnings. Again, this tends to be a relatively short and sharp phase, averaging just nine months.  Goldman contends that we have now reached the following phase of Growth, where earnings estimates are on the up again, but where the valuation applied to those earnings begins to fall – what is sometimes described as companies “growing into their multiple”. Historically, this has tended to be the longest phase, extending to forty-nine months on average. It might not offer the “fast buck” returns of Hope, but it rewards the patient investor with further upside.

The final market phase, which has offered even juicier returns over a twenty-month period, is Optimism, and, as the name suggests, tends to be built on a carefree attitude to risk and a degree of speculation. We might never get to that phase this time – or, perhaps even, in the view of many, we have already been through it!

There is continued focus on the inflationary pressures within the global economy. To a point they are welcome, as they signal a return to robust economic activity. At the same time, though, they could become unwelcome if deemed to be too strong or too persistent (or, potentially, both). Worst-case scenarios lean on the evidence of the 1970s, which featured double-digit annual price rises and interest rates and bond yields to match. We continue to see such an outcome as highly unlikely, not least owing to much less organised labour forces and the improbability of a repeat of the oil price shocks experienced in that decade (when OPEC was a much stronger force and when the global economy was more oil-energy intensive). Even so, it is prudent to hedge against the tail-risk of a more inflationary outcome, even if not to make it the central case.

If you have any questions regarding this update or your own financial planning needs,  please do not hesitate to get in touch on 0117 450 1300.