The amount of very experienced investors asking for a hedge against a deep market correction is sentiment that cannot be ignored.
The average bull market lasts 67 months.
We are at 98 months now. Gone are the days when you can just buy the market and hope to make healthy returns.
If you are an inactive investor you can just close your eyes and sit through the next correction or bear cycle.
In reality, that is what our pensions do.
For the savvy investor, a move out at the top of the cycle and a return following a correction can yield far greater returns.
That pre-supposes, of course, you can identify these cycles in the first place.
Accurately, it cannot be done but prudently we can get close to the top and bottom and that is sufficient to greatly increase returns.
In the good days of interest rates investors could spend some time in cash and bonds and wait for a better time to re-enter the stock markets.
Now cash yields nothing and bonds are a time bomb (be very careful if you are using bonds as a safe play, you need to understand there are many types of bonds and some carry very high risk.
Get some analysis done if you do not understand the bonds in your portfolio).
So, as we stand the S&P 500 (the best global benchmark) has rallied 210% from the 2009 low. We are currently 1.7% off the all-time high which was reached a year ago.
Based on those figures we have had a massive six- year bull market and for the last year we have stalled.
The main reason why we have not fallen back can in large part, be attributed to accommodative central banks and low interest rates.
Investors are reluctant to sell when they see no alternative.
So what lies ahead?
Here are the possible scenarios and an attempt to foretell the most likely outcome:
The market is going to rally to new all-time highs and the bull-run will be sustained.
The market will continue flat for the remainder of the year.
We are going to correct 20% and then recover by year end.
We are going to fall more than 20% and enter a bear market cycle for at least 18 months, correcting by up to 35% in total.
Markets are driven by short-term speculation and long-term economic fundamentals. To cause a correction we only need to create a stampede and that can be done by a quick shock. We need underlying economic fundamentals to cause a sustained bear market.
A panic sell can happen very quickly and last a relatively short time.
The January/February 15% fall this year, caused by the sharp oil price drop is a classic example.
That proved to be an opportunistic event for investors rather than a serious situation.
The serious events that can trigger selling in this market are firstly China growth fears.
Any further bad news on the Chinese economy will cause stocks to be sold.
If the news is bad enough — say, a hard landing — we will get a deep correction. Secondly, the oil price heading back towards $30 would be very bad.
You can pretend commodity producers are solvent if you can argue a higher oil price in the near-term.
If the outlook for the oil price is under $40 for a number of years you have to start providing against losses.
This will cause a very serious market correction.
Janet Yellen raising the US base interest rate over the summer has the potential to also upset the markets.
Geopolitical tensions caused by Brexit and/or immigration in Europe also have the possibility of sending major hedge funds looking for cover.
Finally, the ‘Donald’ effect is not priced in. You can take it from me that the prospect of Donald Trump becoming US president is not a market positive event.
So, any one or a combination of these risks coming into play causes a market correction, while, for the market to continue to rally through the summer months, none of these events can occur!
So as a best guess let’s put a percentage likely outcome on the various scenarios.
The market is going to rally to new all-time highs and the bull-run will be sustained (20%).
The market will continue flat for the remainder of the year (10%).
We are going to correct 20% and then recover by year end (50%).
We are going to fall more than 20% and enter a bear market cycle for at least 18 months, correcting by up to 35% in total (20%).
Maybe the investors looking for the hedge are a sentiment we should not ignore.
Either way, we need an investment strategy that is not based solely on equity performance.
Peter Brown is head of wealth management at Baggot Asset Management. www.baggot.ie
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