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Has the FTSE 100 rallied too far, too fast?

We should be glad the stock market is doing well but a 6% gain in January has got alarm bells ringing.

 

by Gavin Lumsden on Jan 25, 2013 at 16:57

Has the FTSE 100 rallied too far, too fast?

Stock markets around the world have got off to a flying start to 2013. This includes the UK’s FTSE 100 which has soared more than 6% so far in January. Over six months the blue chip index has gained an impressive 15%.

After recent difficult years, it's a relief to see the FTSE 100 hurdle one ‘resistance’ point after another: first 6,000, then 6,100 and 6,200 have fallen this month. Even 6,300 looks in reach after another round of economic indicators this week pointed to recovery in the eurozone, US and China.

(In the event it wasn't as the index closed on 31 January at 6,277, a monthly gain of 6.4% or 379 points. See 'Does a good January mean a good year for the FTSE?' for more analysis.) 

(cont) True, the UK economy is in the dog house, teetering on the edge of another recession with the news today that our gross domestic product (GDP) shrank by 0.3% in the last three months of 2012. But as today's Friday Five points out, many of the big FTSE 100 companies are global businesses, increasingly looking to the ‘emerging markets’ of Asia and Latin America for growth.

The good news is that when it comes to investing your ISA or pension you don’t need to worry about the UK economy quite so much. (Although it is totally pertinent when looking at the pound in your pocket, tax bill, job prospects, benefit cuts etc.)

Yet just as investors are finally enjoying ourselves, a party pooper pops up to tell us to stop being silly and put the drinks away.

I’m referring to Alistair Mundy (pictured), the long-standing fund manager of Investec Cautious Managed (and many other funds), who, appropriately enough, sounded a note of caution this week. Mundy urged investors to reflect on why they might be rushing into shares now, when they didn’t in 2009 when the FTSE 100 hit a low of 3,530 in March after the banking crisis?

Mundy is a ‘contrarian’ who likes to invest when others are afraid to. He wasn’t actually arguing against investing (which fund manager does?) but simply pointing out that with the FTSE 100 having risen so far there was more danger of it falling now than there was four years ago. The ‘downside’ is literally greater the higher you go.

Mundy isn’t against investing, he’s just not excited about the UK stock market, or the US for that matter, preferring countries like Japan and sectors like gold miners which are cheap. (Yes, strange but true gold is expensive but the companies that get the stuff out of the ground are good value.)

Are markets cheaper?

It’s good to diversify your investments outside the UK so I’m not arguing against Mundy. But there is a case to be made that piling into the FTSE 100 when it is back at levels last reached in 2000 and 2007 is not as mad as it may sound.

This may sound odd given that on both occasions the index crashed soon afterwards. However, Lars Kreckel, a global equity strategist at Legal & General Investment Management, makes the point that although stock markets have regained their levels of six and 13 years ago, they are in fact cheaper. This is because US corporate earnings, or profits, for example, have grown by 80% since 2000 and by 10% since 2007. Same price but more profits means the US S&P 500 is around half the price it was in 2000.

Of course, the important question is will companies continue to grow their profits like this? Many investors, like Mundy, think US companies won’t and so aren’t investing in the country very much. Others take the opposite view, saying a recovery in its housing market will feed through to the US consumer and thus into the rest of the economy, while an energy boom from cheap shale gas will allow US companies to maintain their profit margins.

Let’s put that debate to one side. The question is has the FTSE 100 rallied too far, too fast? Has the stock market got ahead of itself? The answer to that is yes, it probably has.

Evidence for this comes from a slightly unexpected source. Analysts at Bank of America Merrill Lynch have been arguing for some time that there could be a ‘great rotation’ this year as investors switch out of defensive, but expensive bonds into better value, higher yielding shares.

What we’ve witnessed in the recent stock market surge is proof that this is happening, that bullish investors are becoming more convinced that, generally speaking, the world is recovering from the financial crisis: that growth, rather than recession, is going to be the order of the day.

But the transition from hordes of investors buying bonds to hordes of investors buying shares is not going to be smooth, says BoA Merrill Lynch. Echoing Mundy, the bank’s investment team argues that a great leap forwards could be followed by a fall or ‘correction’ in the spring.

What happens to bonds

As I try to explain in this week’s Lolly Investor Programme (see video below), the key to what happens is in the bonds market. If there is going to be a global recovery followed by rising inflation and interest rates, bond prices will fall.  

But this could be where things get tricky. When bond prices fall, their yields rise. Yields measure the amount of income a bond’s fixed rate of interest will deliver if you buy at the current price. Government bond yields are seen as a measure of what interest rates will be in the future. If it is thought that interest rates will rise, bond yields will rise first and therefore their prices will fall. We’ve seen a bit of this already this month.

BoA Merrill Lynch paints three scenarios.

1) The good

The best is that as in the early 1960s share prices and bond yields rise steadily. What investors lose on the bonds, they make up for on shares.

2) The bad

However, it warns there could be a repeat of 1994 when growing optimism about the US economy saw another big rotation from bonds into shares. Only then bonds crashed, dislocating financial markets so badly that share prices eventually fell too.

3) The just as bad

Less likely, it says, but equally alarming, there could be repeat of the Great Crash of 1987 when, among other things, equity markets took fright at the speed at which bond yields (which indicate the future cost of borrowing) were rising.

Obviously, the first scenario is much easier to contemplate. So while we should be glad that confidence has returned to stock markets, we should hope that a dash of wintry weather cools things down a little.

34 comments so far. Why not have your say?

HJ

Jan 25, 2013 at 22:09

Do not believe all this garbage about a triple dip recession put out through the news media. My business has grown 40% so far this year. Watch Sterling very carefully and get ready to buy.

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J Bewey

Jan 25, 2013 at 22:43

I am not a bear by any stretch of the imagination but the market is running away with itself. The debt pile in America and the UK alone is bigger than it has ever been. It won't take much to spook the markets and the sharper the rise; the steeper the fall. I got back in in 2010 after sitting the previous 6 years out. I am now banking the gains otherwise I would be like the gambler who wins at first then keeps on playing until he loses. I wouldn't short the market; the fact that I have sold a large portion of my equities means it is bound to keep rising, but I will sleep easier at the moment holding only safe(ish) high yielding shares and hope for a correction later in the year.

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John Glynn

Jan 26, 2013 at 09:42

Back in 2009 investors were cautious because the global economic outlook flirted with the apocalypse and the world was an uncertain place. Although the global crisis is far from over the black clouds are clearing and we are seeing signs of global growth. There is a feeling of stability in the Eurozone. Asia is powering ahead and America is flexing it's muscles. The mire that western economies are in is debt and it is only global growth that will steer us through it.

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Dave P

Jan 26, 2013 at 09:49

Probably in early stages of a long bull market but as always with the emotional factors involved, easy to overshoot along the way. In such an event, good to take small profits on run-ups. "No one ever went broke taking a profit."

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Rob Walker

Jan 26, 2013 at 09:52

There has been a lot of pressure keeping the markets depressed for years when really, alternative homes for investment cash are doing even worse. So when the big drag on the markets - the banks - start to recover it's not surprising to see the brakes come off throughout the equity market. World consumption and production today is far above the 2000-2004 levels so, taking a global view, I'd expect that eventually equity values will rise accordingly, in which case there is still some headroom in the FTSE etc along with some more re-adjustment to reveal the real winners and losers.

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Matthew Charles Flinders

Jan 26, 2013 at 10:43

I hardly think a peak is an ideal time to buy. This has risen too sharply and the FTSE has basically gone up from hearsay. Its a typical santa 'optimistic about the new year' rally.

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John Osborne

Jan 26, 2013 at 11:13

Thanks Gavin for quantifying the risks.

Recovery may be in the air but I think it is based on more hope than substance. As J Bewey points out the western debt piles have never been larger, and there has been no solution to the eu common currency distortions causing such pain in southern europe and elsewhere.

Am keeping to a mostly overseas strategy for my investments.

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Tony Peterson

Jan 26, 2013 at 11:26

Presumably the alarm bells will ring louder still if FTSE rises further in February.

How sweet those alarm bells sound. Bond investors should not stop to ask for whom the alarm bells toll.

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Tortoise

Jan 26, 2013 at 11:30

I work in a local firm of accountants and like HJ many of them saw a significant increase in business in the second half of 2012 and the triple dip recession is a bit of a puzzle. However, I also agree with Mr Bewey that basically, UK PLC is bust and the Euro is still in very thick trees. Not out of the wood by any means. The US is also coming up to its debt ceiling. I have seen some very gloomy forecasts from serious analysts and there may be trouble ahead. I am watching this very closely.

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an elder one

Jan 26, 2013 at 11:38

You can't judge the fortunes of the market by the movement of 2 or 3 weeks into the year; were the current rate of progress to continue, my portfolio (which has appreciated less than ftse100) would achieve a gain of some 85% on the year, which is clearly nonsense; I've seen this happen on a number of occasions; after a while things flatten out.

It's just a blip from investors rearranging the furniture for the new year.

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Tony Peterson

Jan 26, 2013 at 11:50

But, Elder One, don't you remember 1975, when the then main index more than doubled in a single year?

You can only judge the fortunes of the market with hindsight.

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SchumpeterII

Jan 26, 2013 at 11:50

Come on chaps, don't you know a bubble - in this case an equity price bubble - when you see one. All that QE money had to go somewhere, and it hasn't gone into consumption or productive investment, and so, once again, we have asset price inflation. A sense of de javu perhaps.

As has been noted the bond bubble is now at a 240 year high in the US and 300 in the UK, it looks set to burst to me. This will of course mean a spike in long term interest rates and have a delationary impact on any recovery, real or imagined.

There is no recovery just an ongoing crisis which is morphing into a different form. This is what happens when governments and central banks try to manage the trade cycle, simply a different set of problems emerges.

Have a nice day.

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Chris B (Slough UK)

Jan 26, 2013 at 11:54

Looks just like the spike in mid October 2007, just before the markets went to hell! UK Triple Dip, Europe in recession, US debt $6 Trillion plus $22 Trillion unfunded liabilities and a possible whammy from Fanny Mae of $5 Trillion. EU, UK, US and Japan spending is hopelessly out-of-control.

I would imagine the markets would have a normal pull back from here then rise till April, but I wouldn't count on it. After that I wouldn't like to be in the market from May... as they say. When the Bond market turns into worthless paper in many countries, the mire will really hit the spire! Many currencies will fall dramatically in the not too distant future.

UK will exit the EU, because the government will not be prepared to hand over sovereignty in full. At the moment we are stuck between two masters, our government and the EU bureaucrats, both which seem to be fools, whose only interest is serving the banks with total desregard of the long term consequences for the people.

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Chris B (Slough UK)

Jan 26, 2013 at 11:56

Baltic Dry Shipping Index appears to be turning down sharply too.

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Chris B (Slough UK)

Jan 26, 2013 at 11:59

Dr. Copper looks to be in a downtrend.

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Anonymous 1 needed this 'off the record'

Jan 26, 2013 at 12:05

Just because a market has risen when it would have been more logical for it to fall, it doesn’t mean that it won’t continue to rise. We’ve all been here before, the bull is a very stupid animal.

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Lost my marbles

Jan 26, 2013 at 12:10

Yes,the FTSE has risen quite quite quickly,but it will calm down and as always we will see the ups and downs,and the profits of doom together with the uber bulls all having their say.I generally stay invested and now and again skim some profit off the top if I am fortunate enough to make any.I need divis to boost my income and have spread my investments worldwide.

Whether or not we will have a pullback or a right old correction none of us knows,but I am not putting anymore 'hard-earned 'into the markets at the moment.

By the way,look at Alistair Mundy's track record of funds he is involved with...........none too impressive many of them!

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John Osborne

Jan 26, 2013 at 12:44

The advantage of shares over bombs of various description is that provided they are good quality based on sound companies in areas with value they nearly always recover sooner rather than later, whatever the market noise.

Most of my long-term losses in the past have been because of having to sell out at the bottom for various reasons and not capturing the unforeseen upturn.

Perhaps we just need to take the divis and keep calm, or at least I am trying to.

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James O'Connell

Jan 26, 2013 at 13:56

John Osborne

Yep. Bombs always blow up in your face!!

Sorry, I know it's just a typo.

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an elder one

Jan 26, 2013 at 14:31

I stay fully invested (pretty well) and watch; as TonyPeterson days, you can only judge the market in hindsight; but I'm a natural optimist (some may say idiot) by nature and hold long term, still making sensible profit, through thick and thin. Despite the frantic endeavours of some, things I find, move slowly over time; just keep a close eye on the things you hold.

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an elder one

Jan 26, 2013 at 14:35

Arguably, one should ignore the frantic press; after all they make their money out of drama.

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John Osborne

Jan 26, 2013 at 15:45

James,

Yes indeed, my joke as well. I hope not true of this bubble or fallout will be very messy for us all!

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James Bell

Jan 26, 2013 at 18:59

The graphs never travel in a straight line. As a fund investor, I think a sensible approach is to look at your portfolio, look at what has gone up the most and think about your investment horizon.

For my part, i'll need some money this summer so I'm moving the required amount into a cash park now. I'm also more likely to exercise caution with ISA money than with pension pot money (because I might conceivably need the ISA money sooner; I am 37).

Over and above cash requirements, I am starting to cash in (20% per week) (a) my trackers (b) my smaller company funds and (c) other select, equity only, single priced funds. This is with a hope of 'buying back in' later in the year when, inevitably, there is some panic selling.

None of us know what the market is going to do, but (a) I know my trackers are 'stupid' (they won't build up cash reserves), (b) I don't want to be selling a smaller company fund when it is already going down because of the wider spreads on those shares (regardless of how the fund is priced) and (c) I'm not going to try to time the market with funds that have a 6% bid offer spread.

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Tony Peterson

Jan 26, 2013 at 20:13

James Bell

What about shares that have less than half of one percent bid offer spread?

Funds are for wimps.

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snoekie

Jan 27, 2013 at 02:16

Chris, they haven't cought up with the Xmas lay off and hang over, but you are right, so where are the companies making the profits if they aren't shipping?

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Anthony O' Grady

Jan 27, 2013 at 08:35

Marc Faber and Jeremy Grantham are both predicting a 20 per cent correction. With their track record, that's a good enough prediction for me.

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Lost my marbles

Jan 27, 2013 at 10:35

Shame Messrs.Faber and Grantham aren't clever enough to tell us just when this almighty correction will occur!

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Anthony O' Grady

Jan 27, 2013 at 14:56

If they could do that they would be a lot richer than they are, but they do have an impressive track record for forecasting if you take the trouble to do some research.

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Tony Peterson

Jan 27, 2013 at 15:25

I'm sure that you've all had time to digest this weekend's FT by now. You will have noticed that Fidelity have placed a full page ad in the Money section pointing out the great advantages offered by equities now. They obviously anticipate (or they wouldn't have advertised at all) a wall of new money to earmark for new equity purchases.

There's postal times and cheque clearance times to go before Fidelity start moving in on shares in a big way.

I don't really anticipate that "correction" in the coming week.

But, I am sure the day will come when there is a 20% "correction". By the way did these geniuses actually say which way the correction was going?

I"ll be beating Fidelity to the draw this week.

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Lost my marbles

Jan 27, 2013 at 15:34

Anthony...re Messrs.Faber and Grantham;there are just as many other 'experts' telling us that we are in for a good year.

Personally,I don't take much notice of any of them.Yes,I will read what is said and then make up my own mind.

(probably why I am poor!!! Ha-ha!)

Anyway,when I get a minute I shall try and find out what these sages have said.

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Lost my marbles

Jan 27, 2013 at 16:02

Anthony,,just had a quick look at Faber's comments.Yes,he's gloomy alright.

Oh well,in case he is right,just as well I have a bit of cash sitting on the side of my SIPP,but my trading portfolio is almost fully invested.Won't be selling up as I am skewed towards investing for income via funds and utilities and need the divis.Additionally,it is quite hard for mortals to judge when to get back in.

I usually get the tin hat out and hide under the stairs with a bottle of whisky.May be persuaded to take a bit of profit from one or two investments tho'!

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Martina

Jan 27, 2013 at 18:48

Like you marbly I'll be leaving my Income funds well alone for the foreseable future. My UK growth fund on the other hand went stellar through 2012 so I'll be cashing it in this week to pay for a new kitchen suite.

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Anonymous 2 needed this 'off the record'

Jan 28, 2013 at 11:36

One soon learns the truth of the old adage, that there are only two factors which drive equity prices: fear and greed.

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Ahmed (Helsinki-dishu, Finland) via mobile

Jan 29, 2013 at 05:33

Non stop Money printing is finally showing its effect. Asset prices will continue to rise to reflect the increased money supply, nothing to do with improved economic prospects.

Put your money in gold and commodities, and your faith in beloved Allah.

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