While the mood in the main developed markets does not feel heated, professional investors are becoming optimistic and momentum in markets is clearly building. The world index's 13-successive months of positive gains is unprecedented, though this may be more to do with the dollar's weakness than investor euphoria (or Donald Trump for that matter). Money is pouring into more peripheral markets, for example: $450m for a da Vinci painting of doubtful provenance, Bitcoin (enough said), and a rampant IPO market in Hong Kong. The Fed may be reversing QE but let's not overlook that the BoJ and the ECB have pumped $2tr into the system over the last 12 months. These liquidity flows are now below the peak hit last year but the dollar's weakness and easier credit conditions have helped keep the monetary conditions very loose.
Trump is clearly a man where scant attention should be paid to what he says and it is far more productive to watch what he actually does. Thankfully, there is much less of the latter than the former. His more populist policies are confined to Twitter while actual policy has been more conventionally Republican - not a great surprise given a cabinet heavy in Goldman Sachs alumni and ex-Armed Forces Generals. The tax reform bill is making its tortuous way through Congress and it would appear that both Houses have agreed to reduce corporation tax to 20%. If ratified, this is great news for stockmarkets, however, from an economic perspective the need for a fiscal boost at this juncture is at best questionable.
The US market is now looking expensive. The P/B has been creeping up while RoEs have dipped. This contrasts with elsewhere in the world where RoEs have improved, although many of these markets tend to have more cyclical businesses. The fall in US RoE does not sit well with the rise in net debt and Trump's tax cut will only remedy this to some degree. Japan continues to look one of the cheaper markets and we note the improvement in RoE. Quite how much is down to Abenomics and how much can be accounted by the pick up in global growth is moot. Nevertheless we feel that Japan and GEM continue to justify our 'favour' position in our matrix from a valuation perspective.
QE may be interfering with our radar but there are sufficient straws in the wind to suggest that we are entering the latter stages of the bull market. With global growth picking up and interest rates still suppressed it is too early to be leaving the party, but we should be eyeing the exits. Demanding valuations are vulnerable to any disappointment and this justifies our general caution. It does feel that there may be some parallels with the end of the 1990s bull run. The subsequent bear market came about from a profits recession and p/e rerating rather than an economic downturn. Higher costs combined with higher interest rates may be the catalyst this time.
The latter stages of a bull run can often provide the strongest returns. Bystanders dip in once they feel that they cannot afford to miss out and momentum takes over. We may already be seeing the early stages of this. In such an environment, traditional fundamental analysis counts for little and this calls for a reappraisal of our fund positioning. However, from as asset class perspective we are making no changes to our allocation matrix this quarter.
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