From optimism to euphoria

Tom Stevenson
Tom Stevenson
Fidelity Personal Investing24 January 2018

Yogi Berra was a baseball legend. He played in 14 World Series for the New York Yankees, winning 10 of them. But he is better known for his witty malapropisms and nonsensical sound-bites.

‘When you come to a fork in the road, take it’ and ‘no-one goes there anymore, it’s too crowded’ are two of my favourites.

The one that really resonates today for stock market investors, however, is ‘it’s déjà vu, all over again.’

For anyone who was involved in the exuberant markets in the late 1990s, the mood today does indeed feel worryingly familiar. As 2017’s optimism morphs seamlessly into 2018’s euphoria, FOMO (fear of missing out) is taking hold.

It really does feel like déjà vu - all over again.

This week the S&P 500 hit yet another all-time record. At 2,840 the US benchmark has risen by 166 points since the start of the year. That’s 6% in less than a month. If you believe in the January Effect, you are preparing for another stonking year on Wall Street.

In the hottest parts of the market, even that remarkable start to the year looks pedestrian. Netflix, maker of The Crown, saw its shares rise by 10% on Tuesday after it announced faster than expected subscriber growth. The company is worth $100bn. Its shares started the year at $192 and have risen to $250, a 30% rise in less than four weeks.

Even the most grudging bulls - and this long bull-market has been one of the most mistrusted and disbelieved ever - are starting to notice that something interesting is going on. Equity market strategists are queuing up to adjust their forecasts higher as their existing predictions are overtaken by events.

The latest upgrade came from Bank of America Merrill Lynch, which has lifted its year-end target from 2,800 to 3,000. That would suggest a 12% rise this year after last year’s 20% gain and the 10% rise in 2016. With the market having eaten up a fifth of that uplift already, even 3,000 doesn’t look outlandish.

So what’s driving the market higher, is it justified and can it last?

There are two main factors fuelling the recent gains. The first is real - the global economy is enjoying a synchronised upturn for the first time since the aftermath of the financial crisis. The International Monetary Fund kicked off the Davos gathering of the world’s great and good with a significant increase in its expectations for global growth to nearly 4% this year and next.

The Trump tax reforms, passed just before Christmas, are the icing on the cake. To mix the metaphors, they risk pouring fuel on an already smouldering economic fire.

The second key driver is investor optimism and fund flows. Investors are shrugging off the high valuations in the stock market, focusing instead on the even higher valuations in the bond market and deciding that equities are the better place to be. Equity fund inflows are higher than at any point in the past 20 years.

Given the wall of money that has been parked in bonds since the financial crisis, it remains a distinct possibility that a massive rotation out of fixed income and into equities could provide the rocket fuel for the next leg up for shares.

Whether investors are right to justify the overvaluation of shares on the even greater over-valuation of bonds remains to be seen. In the long-run the answer is almost certainly not - high valuations have historically always led to disappointing long-term returns. But no-one is really looking at the long-run today. Not while the short-run potential is so exhilarating.

The last of the three questions - can it last? - is the most difficult to answer. That is because excessive valuation is a poor guide to the short-term direction of the stock market. As Keynes famously remarked, the market can remain irrational a lot longer than you can remain solvent.

Stock markets can stay expensive for longer than you think.

So investors staying in the market now are doing one of two things. Perhaps they simply accept that timing the market is impossible and are staying fully invested because over the long-run shares have provided the best total returns. That is a perfectly reasonable approach. No-one has a crystal ball and pessimism has been an expensive mistake over the years.

The other possibility is that they are playing an increasingly nervous game of chicken. They accept that the stock market has entered the home straight and are hoping to capture some more upside before de-risking their portfolios a little closer to the top of the cycle. This is a rather less reasonable approach, because history suggests it is nearly impossible to do. But it is entirely understandable why someone should want to give it a go.

My view of all this is coloured by my experience of investing through the dot.com boom and bust in the late 1990s and early 2000s.

Between the end of 1998 and the end of 1999, the FTSE 100 rose from 5,883 to 6,930. That 18% rise was just the average. Anyone sitting out the final year of the bull market would have watched many shares rise much faster than this.

Vodafone rose from 200p to 314p in 1999, a 57% increase. BT rose from 635p to 1061p, a 67% rise. These were not penny stocks. They were shares that almost everyone held in their pensions or ISAs.

Sitting out the final months of an epic bull market is impossibly hard. Even if, at some point, it will undoubtedly be the right thing to do.

As Yogi Berra said: ‘it ain’t over ‘til it’s over’.

Five year performance

(%)

As at 23 Jan

2013-2014

2014-2015

2015-2016

2016-2017

2017-2018

 S&P 500

18.3

26.0

-1.1

38.4

13.3

Past performance is not a reliable indicator of future returns

Source: FE from 23.1.13 to 23.1.18. Total returns in Sterling terms


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