Market Musings 01/08/2021: Time to Don Hard Hats?

1st Aug '21 by Edmund Shing

7 comments 2653 reads

Time to don hard hats?

The end of July is here. August and September are typically the weakest months of the year for stock markets, so caution I guess is warranted if you are a stock market investor. European stock markets (like the German DAX) are typically weak over August and September, the US tends to move sideways, while bonds tend to gain.

European stocks suffer, US flatline, bonds gain over August + September

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Source: equityclock.com

However, when we look at the evolution of stock markets this year, the trends remain firmly upwards for now. This is true whether you look at the S&P 500, the Euro STOXX 50, or even the UK stock market. The notable exception is emerging markets, dominated by The weakness in Chinese stocks as the Chinese government chooses to clamp down on tech companies in particular.

Equal-weight S&P 500, STOXX Europe continue to climb

Source: Bloomberg

In theory stock markets remain supported by two strong drivers. these are:

strong earnings growth based on continued economic recovery
long-term real interest rates that have returned to historic lows

US, UK long-term real interest rates return to lows

Source: Bloomberg

Economic growth has peaked

But beware: global economic growth has already peaked, which was inevitable at some point as the impulse from government spending and extraordinarily easy monetary policy weakened. Interestingly, Bond yields have declined despite the rise in inflation rates. This is an unusual state of affairs, and suggests to me that the bond market is concerned about the withdrawal of government spending, combined with a more hawkish Central Bank, particularly in the US.

There is a risk that persistently high inflation could push the Federal Reserve not only to cut back their bond-buying program (so called tapering), but also to raise interest rates sooner than expected. Doing this at a time when growth is already slowing could even tip the US economy potentially into recession, in the worst-case.

US leading economic indicator: growth momentum slows

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Source: ECRI

TINA: There Is No Alternative has finally worked

Judging by the enormous retail investor flows into stock…

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graceevamunro

2nd Aug '21

Thanks for this Edmund - always good to read your analysis.

Can I ask about quality shares - you say that they will have less downside risk. I can imagine this being true at a business level - that is, the quality companies will be less likely to suffer material declines in their business and are less likely to go bust, but is there not a case to be made that the market has heavily priced in quality characteristics? If quality companies are indeed priced at a significant premium, then surely they have further to fall? Especially when compared to more modestly prices shares with lower quality characteristics, where the market doesn't have as high expectations.

Edmund Shing

Hi Grace

This is a good point. Absolutely, valuation is always important when considering the long-term potential in stocks of any type, including Quality stocks. However, it is difficult to look at valuation in absolute, as investors have the choice of investing in different styles of stocks (Quality, Value, Momentum, Growth) as well as other asset classes (property, cash, bonds, corporate credit).

I would just point out that in some markets, quality is expensive (such as the US), but perhaps less so in others. Also one can perhaps seek out cheaper quality stocks in the UK and Europe by looking at quality stocks in more cyclical industries, such as construction, industrial goods and services, or even in financials. This way one can perhaps find quality stocks at lower valuations.

Hope that helps,

Edmund

STXMLD

3rd Aug '21

Interesting article.

How would you distinguish this trend-following strategy from (say) the portfolio-insurance-type strategies that were once quite popular?

4th Aug '21

Well portfolio insurance type strategies are more like the explicit hedging strategies I describe above, while trend-following strategies are more of an asset allocation switching device - this can also be used to switch among a number of different asset classes, not just equities and bonds.

These days, portfolio hedging is done rather using options - e.g. by buying a put option that effectively hedges downside beyond a certain level for a stock market index. But as with all hedging strategies, there is then the cost of buying the option which can mount up over time.

GTrader

Hi Edmund, just finished your book. It gave me some valuable food for thought regards seasonality, not necessarily to be out of the market as per strategy 2 but to focus buying (top up) periods early March and start of October. With bond yields (ignoring retail) near cash I have opted for an equity/cash split but open to adjust as inflation ramps up and maybe bonds come back in play. Thanks for your insights

dickieh

5th Aug '21

Interesting article, thanks. But I don’t think it’s possible to buy PHDG as a UK investor is it? It’s not available at HL or AJB and Saco won’t let me put an order

Rusty2

£PHDG seems available on IG Group (LON:IGG) but not within an ISA. I only have an ISA with them.

Some of the US technology stocks have bounced back nicely since the sell off in early May, maybe time to take some profits?

Market Musings 01/08/2021: Time to Don Hard Hats?

Time to don hard hats?

Economic growth has peaked

TINA: There Is No Alternative has finally worked

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Edmund Shing

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