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An old bull market 'red flag' is back

 
Nick Kirrage
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A bull fight
Bull market fears: An old 'red-flag’ warning is back

The recent turbulent nature of world markets has inevitably led to speculation as to whether this could be the ‘beginning of the end’ of the good run share and bond investors have largely enjoyed in the decade or so since the global financial crisis.

Many commentators have, however, argued this bull market has further to go as we have yet really to see the ‘irrational exuberance’ leg where investors are willing to pay crazy prices for assets.

On our Value Perspective blog, we strive to stay clear of any debate about market strengths and weaknesses.

Being value investors we instead look to valuation to be our guide as to whether we should be buying and selling individual business.

The red flags

We do, however, keep a folder of what we might politely call ‘red-flag market indicators’ – essentially news stories and other developments that make us very uneasy indeed – and it has seen quite a growth spurt in the last few years.

Take, for example, how at the start of 2017 the yield offered by European high-yield bonds dropped below that of the dividend yield of the broader share market.

Think about that for a moment – investors were effectively saying they were happier buying into the bonds of the riskiest companies in Europe than mainstream equities.

Taken in isolation, that might well fit that tag of ‘irrational exuberance’ and yet, the more we add such examples to our folder, the more investors as a group become increasingly relaxed about them – and the next piece of incremental craziness does not seem so bad.

As you might imagine, investors’ reaction to bitcoin and all things blockchain-related have made multiple appearances in our folder over the last couple of years.

Indeed, as we have indicated in posts such as ‘The Bitcoin Perspective’, the parallels that can be drawn between bitcoin and the dotcom boom at the turn of this century are enough to make the hairs stand up on the back of your neck.

The latest red flag

A similar – if less aggressive or commented upon – ‘red-flag’ development has been the reappearance of an old bull-market favourite known as the special purpose acquisition company or ‘SPAC’ for short.

Put simply, this is a private equity portfolio where the managers are given a lot of money by investors – and an equal amount of licence about what they do with it.

As this Financial Times piece ’Charts that matter article’ noted at the end of last year: “Following years of subdued activity after the financial crisis, these lucky-dip deals are back in a big way as markets register new highs. This year [2017] will see investors hand over more than $10bn [£7.1bn] to newly minted companies that only have a vague idea of what they will do with the money, according to SPAC Analytics, a research company.”

That is up some 180 per cent on the 2016 figure and not far short of the record $12bn haul of 2007.

What is more, if you were minded to add to that chart the performance of equity markets over the same period, you would see an interesting – and not particularly reassuring – relationship between the two.

We are not in the habit of making predictions, here on The Value Perspective – and yet it would not be a total surprise if we were to revisit our folder at various points over the coming months as we maintain our ‘Red Flag Watch’ on whether investors are proving ever more willing to pay crazy prices for assets.

Important Information: The views and opinions contained herein are those of Nick Kirrage, fund manager, equity value, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This communication is marketing material.

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