We have now been in a ‘bull market’ for over 8 years, which has continued strongly into 2017.
Unfortunately, cautious investors can expect to earn little or no return for the foreseeable future as fund managers find it nigh impossible to earn a return, i.e. you can’t get blood out of a stone.
The Euro has strengthened against the dollar by circa 10% year to date and this has had a negative impact on Euro investors. For example, the SL North American Equity fund is up just 1.5% year to date as a result.
It is worth noting in this regard that the SL Global Smaller Companies fund has a 40% exposure to the US, which makes the 18% return year to date even more impressive.
8 ½ years is a long time for a Bull market, and it is reasonable therefore to ask if we are due a market correction.
The main argument in support of a market correction is that the valuation investors place on risk assets has exceeded all previous records becoming very expensive on any criteria.
The next concern is that a corrosive long-term trend has continued, namely a slowdown in investment into developed economies, which has put the brakes on productivity growth there.
Increased productivity, e.g. having higher numbers of people in the workforce, producing more, efficiently, is the only way known to economists to improve economic growth. Even if the expected modest rebound in investment across the world materialises, slowing capital accumulation in recent years may already have reduced potential growth. Indeed the long term effect of weak investment in economies is one of the biggest, if not the biggest, challenges facing the global economy.
As against that, there are solid reasons why markets may have entered an era of permanently higher valuations.
The main reason – the most important reason – the driver of valuation is profit. Inflation adjusted annual company profits per share grew by a full percentage point faster over more recent decades (since 1980) than in previous decades.
This alone may not justify significantly higher share prices but it warrants consideration before predicting that market valuations will revert to a long term average.
A second, and hugely important, reason is the secular and durable decline in interest rates. They have been falling for over 30 years and remain virtually at zero levels. Despite the recent spurt in economic optimism longer term interest rates have fallen back (after bouncing higher) to close to all-time lows. Ten-year bond yields, the harbinger of future rates for the wholesale and retail market, are 0.45% in Germany, to 0.07% in Japan and to just over 2% in the US.
[We spoke at length on this in our investment note issued in August 2016 – this is the core reason for continued strong equity returns – please contact us if you would like a copy of this note].
A third reason is Quantitative Easing (QE), whereby Central Banks, particularly in Europe and Japan, continue to print vast amounts of money (an extra one trillion per annum) in an attempt to spur economic activity. QE has had a very positive impact on risk assets in recent years.
Of concern of course is what happens when the Central Banks stop QE? Will markets be able to handle it? Or will they panic if this major support line is withdrawn? The US is moving away from QE and is now in a cycle of increasing interest rates. To date markets seem to have been able to handle it.
It is difficult if not impossible to call the top and bottom of markets and to predict the next bull or bear market. What we do know is that markets move very fast, so it is important that investors have their investments positioned correctly taking a long-term view.
Time is therefore a major consideration is deciding on an appropriate level of risk.
To illustrate the importance of time in the markets, if you had invested in the S&P 500 Index (i.e. 100% in equities) in October 2007, at the peak of the market and just before the Great Recession unfolded, the value of your investment would have fallen by 46% by March 2009.
Many people would have “cashed-in” at that point, fearful of losing their entire investment.
However, if you had remained invested, the value of your investment today would be up by 146% on the amount that you invested before the 2008 crash (Note the increase from March 2009 to date is 350%).
This illustrates the importance of remaining invested even in very difficult times.
If you expect to need access to your investments in the short – medium term then there is a strong case to scale back on risk and retreat to cautious assets.
But if your investment horizon is medium to long term, then there is a strong case to continue to hold a good diversified portfolio of risk assets.
We have spoken at length over the years about the opportunities in Smaller Companies.
Please contact us if you would like us to reissue any of the notes we have issued in this regard.
Again we reiterate that these are not small companies, they are just smaller than very large (blue chip) companies. Typically, the Market Cap of the smaller companies we’re talking about is in excess of €2 billion.
We continue to recommend the Standard Life Global Smaller Companies fund and the Standard Life Euro Smaller Companies fund to risk investors.
The investment process of these funds aims to exclude low-quality, risky companies and focus only on identifying higher-quality companies. The breadth of the global small-cap universe provides a range of countries and sectors in which to seek compelling opportunities.
Here are some examples of the type of companies that are held in the funds.
1. Fever-Tree, a producer of premium drink mixers who continue to hit new highs as gin and tonic consumption increases. In 2016 the UK alone drank 1.12 billion gin and tonics, with gin breaking the £1bn sales mark for the first time ever. Britain remains Fever-Tree’s largest market, although the company has expanded into 65 countries.
Fever-Tree shares have increased by 125% over the past year, and are up circa 1,200% since its IPO in November 2014.
2. Sunny Optical, a Hong Kong-listed company that makes camera modules and lenses for smartphones and vehicles. The company is benefiting from the transition to dual cameras on the back of smartphones, which give sharper pictures. Sunny is also the world leader in vehicle lenses, with increased adoption likely in coming years due to legislation in Europe and the US, and the arrival of autonomous vehicles.
Sunny Optical shares have increased by 226% over the past year.
3. Align Technology, a US company and market leader in clear dental aligners under the Invisalign brand. Sales are growing in excess of 20% annually as these displace traditional fixed wire braces with less noticeable, more comfortable and more effective aligners. Technological innovation and patent protection provide barriers to entry, which should help provide sustainable market leadership and continued market penetration. Innovation such as the company’s SmartTrack aligner material has enabled it to halve treatment time, extending its lead over the competition further.
Align Technology shares have increased by 106% over the past year.
4. Teleperformance, a French company that is the global market leader in call-centre operations, is gaining market share as more businesses outsource to specialist firms. The outsourcing trend has a long way to go, as 75% of call centres are still operated in-house according to a study by Everest Group, which provides ample room for growth.
Teleperformance shares have increased by 35% over the past year.
Such firms provide good examples of the diverse range of investment opportunities to be found in the small-cap segment of the global equity market. When this approach is implemented successfully, it can lower portfolio volatility, especially during market downturns, and increase returns. In the small-cap universe, higher risk does not necessarily equal high return, and our view is that it is often in the lower-risk companies that the best long-term investments can be found.
We continue to review our clients’ investments on an ongoing basis to ensure they are positioned correctly, and we continue to conduct regular reviews with our clients to ensure that we are fully up to date on their personal and financial circumstances. If your circumstances have changed since we last conducted a review, I would encourage you to make contact with us. Or if you have any concerns about how your investments are positioned please call us on 01-6144362.
Please be aware that equities are risk investments which can fall as well as rise in value and investment choices should be made bearing in mind your particular personal circumstances.
Please contact us on 01-6144362 should you wish to discuss any of the above in more detail.