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Gloomy news has not stopped shares going higher

Tom Stevenson

Tom Stevenson - Investment Director

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

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This article first appeared in the Telegraph

Taking their cue from Wall Street, stock markets around the world continue to hit or approach new highs. This is despite the fact that news headlines since the beginning of the year have been consistently negative. In the face of coronavirus, Middle East tensions and the impeachment saga, the eleven-year bull market sails on regardless.

This disconnect may seem puzzling at first sight, but it reflects the different priorities of investors and the consumers of 24-hour news channels. To make sense of the market’s response to events - even better, to anticipate it - we have to view the world through a different, less emotional prism and unlearn our instinctive reactions.

There is a good reason why happy stories have to work so much harder to make the front page. It is the evolutionary programming from our days roaming the Savannah - the fact that humans are hard-wired to respond more to doom and gloom than to positive news.

If spotting threats and risks is the difference between eating or being eaten, we are likely to become highly attuned to negative signals in our immediate environment. These instincts are firmly embedded in the parts of our brains that determine how we behave under stress.

One of the most important biases affecting investors is the mistaken belief that big equals important. Every piece of information we process can be judged in two dimensions - its strength and its weight. Confusing one for the other will lead to us to under- or over-react to news.

All three of the bad news stories that have hit the headlines in the first few weeks of 2020 have tried to lure investors into this trap. Impeachment, for example, certainly had strength as a news story (it had only happened twice before) but it lacked weight because the Republicans in the Senate were never going to vote Donald Trump out of the White House.

The sabre-rattling in the Middle East a few weeks ago had the potential to carry more weight because it threatened supplies of the world’s most important commodity. But the market was right to assign little significance to the story. Neither side had any real incentive to escalate the situation and oil analysts quickly judged that the world’s problem is too much, not too little, oil.

The jury remains out on whether the coronavirus story has the weight to match its undoubted strength. So far, the drama is most evident at the human level. It is becoming noticeable at the micro-level of, still relatively isolated, company profits warnings from the most affected sectors (Burberry, Cathay Pacific, Yum). But it is not yet impinging on the macro-level of Chinese, let alone global, GDP growth.

The strength of the story is undeniable. Deserted city streets, cruise liners turning into quarantine prisons and closed borders all make dramatic headlines. But the weight is, at this point, far from crushing. According to the World Health Organisation, more than a million people a year die in car crashes, in excess of 3,000 a day. That’s four times the death toll to date from coronavirus - every single day. The alacrity with which markets welcomed China’s halving of import tariffs shows how the authorities retain the ability to offset the likely economic impact.

This is not to trivialise the outbreak, or to be complacent about how it could develop from here. But investment is in large part about weighing probabilities. And the odds currently remain shorter on a relatively benign outcome than a catastrophic one.

What else can we learn from the market’s reaction to this year’s dramas? First, that investors’ response to events can provide insight into the underlying direction of travel of a market. When the Americans assassinated Qasem Soleimani in Baghdad, the oil price somewhat reluctantly edged above $70 a barrel. It was as if oil felt duty bound to stage a rally, but its heart wasn’t in it. At the slightest whiff of a Chinese slowdown, however, crude has tumbled. The underlying momentum in oil is clearly downwards.

When it comes to shares, the opposite seems to be the case. The eagerness of investors to buy the dips and the speed with which the bull market has regained its mojo is a sign of the fundamental strength of the market. Taking risk off the table seems, well, risky today.

The second lesson I would draw from recent market moves, and it is related I suppose, is that investors tend to see what they want to in the headlines. Temperamentally optimistic equity investors and typically more pessimistic bond buyers are looking at the same stories but coming to different conclusions.

Even as the stock market hits new highs, bond yields are heading lower again. Investors are seeking the safety of government bonds at the same time as they seem to be embracing risk with their shares. Actually, scrape beneath the surface and there is less contradiction than you might think. If you compare the performance of Nasdaq, the S&P 500 and the Russell 2000 smaller companies index, it is clear that investors have a pronounced preference for big, apparently safe, growth-focused shares. This, in other words, is a very cautious bull market, one that lacks depth or conviction.

Which brings us back to why investors are pushing shares to new highs despite all the gloomy news. They believe that the ultimate driver of markets, corporate earnings, is still heading in the right direction. But, while there remains so much uncertainty in the world, they prefer to shelter in the parts of the market that can deliver that growth whatever the headlines are telling us.

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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