Are We In A Stock Market Bubble?

Wealth

October 30, 2017 | BY Richard Newell

Making smart investment decisions can be challenging when everything seems expensive

Even the threat of nuclear war can do little to dent the irrepressible rise of stocks these days. In the 12 months to mid-September, most major world stock markets have had a very good run.

The S&P 500 is up over 17 per cent, the Hang Seng Index almost 20 per cent, Japan’s Nikkei is up 23 per cent and the regional index MSCI Asia Pacific has put on more than 18 per cent. Don’t be fooled, though; trees don’t grow to the sky and when people start asking if this is the “new normal” for asset valuations, it’s time to look for the exit door. We have been here before, several times over the past 20 years, and the outcome was always the same.

There’s no need to panic, but careful investors will now be taking defensive measures. While market pundits may have differing views on the likelihood of a stock market crash in the near future, they all agree there will be some sort of a correction in the next 15 months. Global growth is still healthy, so there is no major crisis looming that might trigger the sell-off.

The IMF forecasts that global output will grow 3.5 per cent this year and 3.6 per cent in 2018, but major research agencies are talking about a US recession in 2018 or 2019. Asset prices have been underpinned by the quantitative easing programme adopted by central banks such as the US Federal Reserve and the ECB in Europe after the global financial crisis of 2008. That central bank liquidity tap is about to be turned off.

In mid-September, the Fed started unwinding the post-crisis quantitative easing programme. How the world readjusts back to realistic valuations of equity risk is going to be a major test. New Zealand-based investment adviser Jonathan Eriksen said, “There’s bound to be some shock waves on the way, so in that sense we expect a market correction of quite large proportions either this year or next year.”

 

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The Fed says it will be a gradual and predictable process that will cause little to no market disruption—like “watching paint dry,” as chair Janet Yellen termed it. Adeline Tan, head of advisory at consultants Mercer in Hong Kong, said clients are right to be wary of the increased market risks.

“The data is telling me to expect the unexpected,” she said, adding that clients who had met their investment targets were now more focused on capital preservation. How should you respond when everything in the world seems overpriced? The answer is to diversify growth asset exposure while adding protection to portfolios. Talk to your wealth adviser about ways of protecting your portfolio.

For example, when market volatility is low, as it is now, options can be bought at relatively low cost. If volatility rises, those options will provide some downside protection. Multi-asset funds have been popular with private bank clients in recent years. Astute managers of multi-asset funds are now putting more into cash as a buffer.

So-called “alternative” investment strategies are also gaining meaningful traction among high-net-worth investors to provide the risk-dampening properties of asset diversification. These assets include alternative debt in various subsectors, such as high yield, emerging markets and private credit.

Although higher US yields will be a headwind to Asia markets, M&G Investments’ Asia director, Jeik Sohn, thinks strong earnings growth has been the major factor driving equity markets, and the current upward path should continue.

“A slow rate-hiking cycle, which is exactly what we are experiencing, should limit panic selling that occurred during the ‘taper tantrum’ in 2013.”

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