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“Be braver for longer”: Fidelity calls the final phase of the bull market

19 October 2017

In its quarterly outlook, Fidelity’s strategists say the environment remains benign for equities although investors need to be aware that the end of the bull run could be in sight.

By Gary Jackson,

Editor, FE Trustnet

The current bull market in equities is likely to continue for some time despite high valuations and mounting headwinds, according to strategists at Fidelity International, although investors should start to prepare for the run entering its final phase.

Markets recently passed the 10 years since the start of the financial crisis milestone and the last decade has been a good one for investors in risk assets. FE Analytics data shows that the MSCI AC World index posted a 134.23 per cent total return (in sterling) over the past 10 years, with the US being the best regional performer with a gain of close to 200 per cent.

In its Q4 2017 Investment Outlook, Fidelity noted that the current bull run is the second-longest in post-war history but added that it is arguably the most hated. As it continues to grind on despite the growing worries of investors, the drivers of the bull market are starting to look “increasingly played out”, the group’s strategists warned.

Performance of indices over 10yrs

 

Source: FE Analytics

“Valuations in some areas are certainly becoming stretched, but overall they remain some way off the peaks seen in 2000,” the asset management house’s strategists said.

“Fundamentally, we are still in the goldilocks low-growth, low-inflation environment that has provided a benign backdrop to markets for some time. Indeed, leading indicators have improved slightly, and growth has become more synchronised, while subdued inflation in the US – despite a tight labour market – has given markets reason to believe there is wiggle room within the Fed’s interest rate outlook.

“The uneasy imperative for investors then is to be ‘braver for longer’. The caveat is to do so while introducing incremental steps to manage downside risk in portfolios.”

Strategists at the group point out that there are a number of reasons to be negative on the outlook for equity markets from here – but there are also enough reasons to rule out an immediate correction.


For example, the S&P 500 has been hovering around the 2,400 mark for several months and it is possible to make a compelling argument for the index reaching as high as 2,700. While further expansion of valuation multiples is unlikely given how stretched they are at present, the US is seeing double-digit earnings growth that could drive stocks higher.

However, there are fewer arguments for the index moving much further past 2,700. Fidelity added: “When the market runs out of fundamental reasons to go up, then we are essentially entering bubble territory. We have already seen some remarkable price moves in some hot areas of the US stock market that look to be sentiment driven.”

That said, history suggests the bull market could continue without significant upheaval, according to the strategists. Given that an early exit by investors could leave a lot of potential return on the table, many could be unwilling to sell up until a turning point is clear and present.

Comparing bull market returns

 

Source: Fidelity International

Momentum is a strong force in equity markets, especially when it comes to the US. And, as Fidelity’s outlook pointed out, S&P 500 dividend yields remain higher than the 2 per cent yield being offered by 10-year Treasury yields – providing some relative valuation support for stocks.

“Nevertheless, we are moving closer to the end of this cycle – it’s impossible to say exactly how long is left, but for the time being it is a case of hanging on, while increasingly thinking about how to add protection against downside risk,” the group said. “The collapse in real interest rates over the last 30 years has been a key secular tailwind for markets. If real interest rates move back up, that may be the catalyst that heralds a new regime.”

In Fidelity’s view, there are two possible ways this “new regime” could be ushered in: one painful and the other a little more gentle.


“The first scenario is a parabolic boom and bust where loved areas of the market become more and more expensive; this would be characterised by greater complacency around valuations and more evidence of ‘fear of missing out’ behaviour among investors,” the group’s outlook said.

“The second scenario is more benign. With two traumatic boom-bust markets in living memory, we may never see the euphoria typically associated with bull markets in this cycle. Instead, we could see a long period of consolidation - a ‘sideways’ market in terms of average market levels, but with de-ratings and re-ratings beneath the surface.”

A key argument supporting this more benign scenario is the amount of excess capital still in the global economy: corporate balance sheets have a lot of cash on them while private equity funds are sitting on as much as $1trn waiting to be deployed.

This suggests that any material falls in markets could attract buyers in the form of business and private equity funds, which may prevent the drop from progressing too far.

Regardless of which scenario emerges, Fidelity’s strategists argued that now is not the time to be tracking stock markets: “While different in character, both these possible outcomes argue for an active approach to equity investments.”

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