A number of years ago, Ian Woolley and I wrote a series of articles attempting to debunk some of the jargon that afflicts the world of investment and financial markets*. In one of these, we tackled the issue of what it is that defines a ‘bull’ or ‘bear’ market. Trust me, it is much more interesting than it sounds. The nub, though, is that the answers lie with the beholder. There are no definitions. Instead, we have what we may call ‘accepted wisdoms’. These typically have neither foundation nor discernible history; like Mr Benn’s shopkeeper, they appeared as if by magic.
First amongst equals is the accepted wisdom that the definition of a bear market is one that has fallen by a minimum of exactly 20% from its peak. 19.9%? That’s fine. 20%? Bear market and run for the hills. The level of 20% has taken almost mythical importance, whereas it has none at all, beyond indicating the unwelcome detail that whichever market has fallen by a fifth. This is where we find the S&P 500 Index, the flagship for both US and global equities. It has dropped by very nearly 20% from its peak at the start of the year, leaving the keyboards of the investment world poised to declare that it is ‘in a bear market’.
The mathematical niceties make no difference. For us, a bear market is as simple as one in which the trend is clearly downwards (the reverse being true of a bull market). On this basis, the majority of the world’s equity is currently in a bear market. There are very few exceptions, though the one that stands out most clearly is the UK. The MSCI UK Index (licence issues preclude us from mentioning a comparable, better-known Index) has moved broadly sideways throughout 2022 and this morning stands 2% higher than at the start of the year.
This tells us a great deal about the composition of indices and very little about the wider performance of equities. Equity indices are typically weighted according to the size of their components: the largest companies make the greatest contribution to the performance of the index. In the United States, the S&P 500 and Nasdaq have become dominated by the large technology companies: Microsoft, Apple, Amazon.com, Facebook (now rebranded as Meta Platforms Inc) and Alphabet; the same companies that are now, for right or wrong, at the centre of investors’ selling pressures. In the UK, the indices of large companies are dominated by 10-15 stocks of mixed blessings. These are the same stocks that have led the UK to underperform most of the world for two decades, but which now have their 15 minutes back in the limelight: the oil majors, the miners, the tobacco companies, the banks. For context, the MSCI United Kingdom Mid Cap Index has fallen by 19% over the year to date.
Last week it was confirmed that the annual rate of inflation in the UK is now 9.0%. The Bank of England expects that the rate will rise to over 10% in the autumn. In the United States, the latest measure put inflation at 8.3%. Despite some hopes this might be the peak, it is likely to move higher yet before topping out in the autumn or early winter. Between now and then, the focus of the markets will probably change from pondering how high inflation might get to how much damage to economic growth the Central Banks will wreak in bringing prices back down again.
The messages from the markets on this topic have been mixed. According to Factset’s data, the S&P 500 Index is trading on a forwards p/e multiple of 16.4. This is below its 10 year average and around 30% below 2020’s peak rating. It is far from clear how much of the fall in the market has been due to a de-rating of stocks, and how much is attributable to an expectation that forecast earnings are too high. A reasonable assumption is that it has been a combination of both, but with a bias in favour of the former. If that is the case, then the coming months will probably see a greater importance placed on the latter. If earnings expectations are not too far out of kilter with reality, then markets are arguably already looking good value. On the other hand, a lowering of profit forecasts is likely to lead to a bumpy summer.
Finally, well done to everyone who knew last week’s opening lines from Take My Breath Away. Keeping with the respiratory theme, which cracker begins with: “If I could make a wish, I think I’d pass. Can’t think of anything I need: no cigarettes, no sleep, no light, no sound, nothing to eat, no books to read.”?
Jim Wood-Smith – CIO Private Clients & Head of Research
*”To P/B, or not to P/B”. Still available should anyone wish to have a copy.
All charts and data sourced from FactSet
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