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Market risks abound — but there are potential rewards

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Sometimes things are obvious. That was true in late February when an overpriced market hit a seemingly terrifying virus. The market started to crash.

I wrote that you would be mad to buy the dip. It was true again in early March. Things were beginning to look too cheap, virus or no virus. Start thinking about what to buy, I said.

Then came the end of March, the point when you really needed to be buying. I wasn’t sure that you should go all in (most bear markets test their lows a few times). But most markets were at 20-year lows in terms of their Shiller cyclically adjusted price to earnings (Cape) ratio, one of the better indicators of long-term value. On a decade view, 90 per cent of markets were showing negative returns.

It’s time to buy, I said — and in particular to buy the likes of Facebook, Amazon, Netflix and Google. For years they had been too expensive for me to feel safe suggesting you go all in. But in March they seemed to be not only less expensive but also providing the few services we both really needed and could still access. There was no price not worth paying for that!

So here we are, nine months on. Somewhat miraculously, my March buy-now-for-the-long-term column came a mere three days after global markets bottomed (over 30 per cent down), something I hope will go some way to making up for some of my less well-timed calls over the past few years.

The S&P 500 is up 65 per cent since. The FSTE 100 is up 31 per cent. Amazon is up 92 per cent. Anyone who held their nerve and sold nothing into the crash would have been evens within five months.

What next? Everything seems to move so fast these days — note that the average recovery time for global markets after a fall of this magnitude is 29 months, say the analysts at Schroders. Has the long term already come? Look at valuations and you might think so.

The global stock market is now 8 per cent above its pre-Covid panic peak. Global stocks are 45 per cent more expensive than their 15-year average in price to sales terms. The US market is on a forward price/earnings (PE) ratio of 23 times, just as it was in 1999, and most tellingly of all the Shiller Cape has just exceeded its October 1929 peak. Its current level of nearly 32 times has only ever been exceeded before at the height of the dotcom bubble, says Albert Edwards of Société Générale. Add it all up and “US equities have never been as expensive as they are right now”. Yikes.

Yet despite all this scarily compelling data, pretty much everyone is bullish. At a recent Pictet Asset Management webinar, 81 per cent of those asked in an online poll said they expected equities to be the best performing asset class of 2021. Fund managers are mostly very bullish — a recent survey suggests their cash levels are down to 4 per cent (this is the kind of number that usually suggests they are a bit too enthusiastic).

They are still overweight the US and technology, but also busily saying they are buying into the reflation trade — banks, commodities and anything consumer focused. They are, they say, all in.

And Robert Shiller, the man behind the Shiller Cape? He doesn’t believe the message his own measure is sending us any more either. The blip in March aside, the Cape has now been so high for so long (this isn’t supposed to happen) that he has had another look at it.

He has produced a new measure — the Excess Cape Yield or ECY — which attempts to adjust for today’s super-low interest rates. The point here is simple: the lower interest rates are and hence the less we can get for our cash, the more highly we will value income streams from other sources. Look at it like this and — ta-da! — US stocks aren’t actually expensive but perfectly reasonably valued. The ECY is 4 per cent, a level from which stocks have returned an average of 5 per cent a year in real terms for a decade. I think we’d all be happy with that.

Mr Edwards is not convinced. He likes to remind us all that in early October 1929, Yale economist Irving Fisher announced that to his mind, “stock prices have reached a permanently high plateau”. Is Shiller the new Irving? Our very own canary in a stunningly overpriced coal mine?

Maybe. Maybe not. The first thing to remember is that markets don’t price the present. They price the future. And next year looks nothing like the kind of years that usually follow severe recessions. The Covid problem should be all but gone by the end of the first half of 2021. Remember that once you have vaccinated the over-75s you’ve removed nearly all the mortality risk.

Personal and corporate balance sheets are much healthier than in any normal recession. Anyone thinking about the health of global demand should keep this fact at the front of their mind: this year central banks globally have printed $8tn — that’s close to 10 per cent of global GDP.

There is not usually a hugely strong demand recovery a matter of months after GDP drops by double digits. This time there is. Next year corporate earnings will soar — and P/E ratios will fall accordingly.

The second point is that we may be about to enter a new age of surprise inflation as demand rises and supply struggles. Analysts at Gavkal Research point out that Chinese factories are already “struggling” to keep pace with US demand. If so, and assuming interest rates stay low, what are the choices for investors who want to maintain the real value of their wealth? A large part of the answer to that has to be equities.

There is risk aplenty here — in the vaccine, in government and central bank policy error and in consumer behaviour. We are no longer in a world in which you can buy anything and wait to be rich. So while you should stay in the market, you also need to cut your risks by pivoting your portfolio from expensive stuff that has benefited from Covid-19 to cheaper stuff that will benefit from end of Covid.

That’s the UK (the only cheap market left); Japan (which tends to perk up as the global economy does); and possibly China and emerging markets. None of this has the glorious absoluteness of markets in February and March. But that ambivalence does at least represent something of a return to normality.

Merryn Somerset Webb is editor-in-chief of MoneyWeek. Views are personal. merryn@ft.com. Twitter: @MerrynSW





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Gensler raises concern about market influence of Citadel Securities

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Gary Gensler, new chair of the Securities and Exchange Commission, has expressed concern about the prominent role Citadel Securities and other big trading firms are playing in US equity markets, warning that “healthy competition” could be at risk.

In testimony released ahead of his appearance before the House financial services committee on Thursday, Gensler said he had directed his staff to look into whether policies were needed to deal with the small number of market makers that are taking a growing share of retail trading volume.

“One firm, Citadel Securities, has publicly stated that it executes about 47 per cent of all retail volume. In January, two firms executed more volume than all but one exchange, Nasdaq,” Gensler said.

“History and economics tell us that when markets are concentrated, those firms with the greatest market share tend to have the ability to profit from that concentration,” he said. “Market concentration can also lead to fragility, deter healthy competition, and limit innovation.”

Gensler is scheduled to appear at the third hearing into the explosive trading in GameStop and other so-called meme stocks in January.

Trading volumes in the US surged that month as retail investors flocked into markets, prompting brokers such as Robinhood to introduce trading restrictions that angered investors and drew the attention of lawmakers.

The market activity galvanised policymakers in Washington and investors. Lawmakers have focused much of their attention on “payment for order flow”, in which brokers such as Robinhood are paid to route orders to market makers like Citadel Securities and Virtu.

That practice has been a boon for brokers. It generated nearly $1bn for Robinhood, Charles Schwab and ETrade in the first quarter, according to Piper Sandler.

Gensler noted that other countries, including the UK and Canada, do not allow payment for order flow.

“Higher volumes of trades generate more payments for order flow,” he said. “This brings to mind a number of questions: do broker-dealers have inherent conflicts of interest? If so, are customers getting best execution in the context of that conflict?”

Gensler also said he had directed his staff to consider recommendations for greater disclosure on total return swaps, the derivatives used by the family office Archegos. The vehicle, run by the trader Bill Hwang, collapsed in March after several concentrated bets moved against the group, and banks have sustained more than $10bn of losses as a result.

Market watchdogs have expressed concerns that regulators had little or no view of the huge trades being made by Archegos.

“Whenever there are major market events, it’s a good idea to consider what risks they might have placed on the entire financial system, even when the system holds,” Gensler said.

“Issues of concentration, whether among market makers or brokers at the clearinghouse, may increase potential system-wide risks, should any single incumbent with significant size or market share fail.”



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European markets recover after tech stock fall

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European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.



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Yellen says rates may have to rise to prevent ‘overheating’

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US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.



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