History doesn’t repeat itself, but it certainly rhymes

17 June 2022

David Jane
Premier Miton Macro Thematic Multi Asset Team

Every market cycle is both similar and different, characterised by a period of easy money and excessive speculation, followed by liquidations and collapses. The QE of the past decade, combined with low interest rates, drove the excesses which are now unwinding. As central banks have bought large proportions of the available ‘low risk’ assets, investors have been driven into progressively higher risk assets in the search for positive returns. Stoked by unprecedented amounts of money creation in recent years, this has fuelled a huge bubble in many areas.

The lockdown disruption and aggressive fiscal policies finally caused inflation to shift from financial assets into the real economy. Central banks, particularly in the US, are responding with rate rises and more importantly the ending of QE. While they are not yet selling assets, they have stopped expanding their balance sheets, allowing existing assets to run off. This liquidity contraction is driving the current bear market.

As in every cycle, there will be some spectacular blow ups and some of the candidates are becoming evident. Asset classes that collapse are generally the ones which are subject to the most leverage as this leads to forced selling once the direction turns down. Two obvious candidates are the crypto-sphere and the private equity arena. Originally billed as a non-government controlled means of exchange, the antidote to QE if you like, crypto eventually became the opposite. Its success has attracted the creation of large numbers of alternatives (to Bitcoin), including some ‘pegged’ to the US dollar, known as stable coins, which have become a key component of the whole crypto-sphere. Crypto now has also become largely an exchange traded market with assets held in custody; this and the existence of stable coins has made crypto essentially ‘fiat’ (trust based). If, as seems probable, several crypto exchanges and many stable coins turn out to be no more than Ponzi schemes, a huge amount of the wealth will evaporate overnight. Just like when the housing market blew up in the US, this will have knock on effects not just on other asset classes but also the real economy. The apparent value in crypto has been leveraged to invest in other areas and the wealth effect from this bubble will have partly driven consumption.

Another area of obvious malinvestment, which is also now beginning to unravel, is the private equity and public growth stock arena where huge valuations have been placed on businesses with little revenue, let alone profit. This is a feature of most recent market cycles but has been at least as extreme in the current one as the tech bubble in 2000. The problem here is the age old one of funds marking their own homework. E.g. funds have been valuing their own private equity assets. This becomes a problem when losses in the public equity portion of open ended funds cause investors to want to get their money out leading to the necessity that the private holdings must be sold. This is what happened on a small scale to a certain high profile UK income fund manager, but it is now happening on a wider scale in the US market. Again, the knock-on effect on the wider market is the same, driving down the prices of what can be sold as well as what should be sold.

There is a counterpoint to the malinvestment caused by the overexuberance of recent years. This is the underinvestment in the core building blocks of the real economy. This includes areas such as energy, mining and basic infrastructure, which explains why productivity growth has been so poor. These have been starved of capital as money crowded into the more fashionable arenas. Indeed, ESG concerns often led to the active discouragement of the necessary investment. Demand for such products may fall if the economy falls into recession, although to a much lower degree than more discretionary items. However, returns in these areas will likely remain high over the coming years, until supply catches up with demand.

We remain highly cautious at the present time, as financial conditions are evidently tightening and leading indicators suggest economic conditions are worsening. There appears to be no obvious sign that inflation is abating, hence central banks are set on the path of further aggressive tightening over the coming months. While our preferred areas of energy, consumer staples and materials continue to do relatively well, we maintain a conservative overall equity position and a very defensive bond positioning.

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Risks

The value of stock market investments will fluctuate, and investors may not get back the original amount invested.

Higher inflation can lead to some investments falling in value, particularly those with a fixed level of interest, for example government bonds and corporate bonds.

Changes in central bank interest rates can affect all types of assets, in particular, securities such as government bonds and corporate bonds that generally offer a fixed level of interest. If interest rates go up, the value of a bond may fall, and vice versa.

Property values can rise and fall sharply depending on the strength of a country’s economy.

Alternative investments typically behave differently to traditional investments such as bonds and equities. They can include a range of assets such as specialist lending, private equity, hedge funds and gold. Adding alternative investments to a portfolio can help to make it more diverse but can also make it more volatile.

Forecasts are not reliable indicators of future returns.

IMPORTANT INFORMATION:

For Investment Professionals only. Not for onward distribution. No other persons should rely on any information contained within this document.

Whilst every effort has been made to ensure the accuracy of the information contained within this document, we regret that we cannot accept responsibility for any omissions or errors. The information given and opinions expressed are subject to change and should not be interpreted as investment advice.

All data is sourced to Premier Miton unless otherwise stated. Persons who do not have professional experience in matters relating to investments should not rely on the content of this document.

Issued by Premier Miton Investors. Premier Portfolio Managers Limited is registered in England no. 01235867. Premier Fund Managers Limited is registered in England no. 02274227. Both companies are authorised and regulated by the Financial Conduct Authority and are members of the ‘Premier Miton Investors’ marketing group and subsidiaries of Premier Miton Group plc (registered in England no. 06306664). Registered office: Eastgate Court, High Street, Guildford, Surrey GU1 3DE.

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The content of the pages of this website is for your general information and use only. It, and the products and services described within it, are subject to change without notice. We shall not be liable to you, or any third party, for any amendment, modification, suspension or discontinuance of any product or service described on our website. Neither we, nor any third parties, provide any warranty or guarantee as to the accuracy, timeliness, performance, completeness or appropriateness of the information and materials made available on this website.

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