Volatile markets reflect fears of reality

mind the gap

Many refer to the growing gap between the reality of Covid-19-torn economies and equity markets. Battered businesses trying to adapt to social distancing and closures struggle to generate profits, to meet rent bills – or pay dividends. At the same time, major equity indices hit new highs.

Most of us run with the wind, which is still behind share price rises. A few point out the dangers and wait for the market retreat they have forecast.

The first few days of 2021 have started strongly for equities. Investors have told themselves this is the storm before the virus lull, the pandemic recession before a strong recovery. They do not want to miss out when the ‘all clear’ is sounded and people return to travel, tourism, leisure and hospitality.

Others, seeing the market trend, congregate around sectors and companies that can do well even in current conditions to protect portfolios if the pandemic worsens. Many rightly point to what they see as the two-way bullish bet before investors. If all goes well, vaccines roll out and we get a strong recovery so companies and shares benefit. Profits and dividends catch up with expectations. If the vaccines are delayed, or if a new variant defeats them, or if governments are slow to lift restrictions, there will be plenty more money and stimulus along from central banks and governments.

But we need to remember that there are several ways markets can come down again.

Fear and greed

The markets are showing signs of excessive greed and occasional fear. Some favoured areas such as green energy and electric vehicles attract huge buying interest, moving the available share prices to discount years of growth and success well in advance of it happening.

The global-clean-energy index produced a return of around 140% last year and is up sharply again so far this year. Tesla has seen an even more extreme share price performance, up 11% so far this year taking it to more than eight times its level a year ago. It had a sharp fall of more than a quarter at the beginning of September 2020 during its huge rise. It is a reminder that there is a lot of hope value in trendy areas. Tesla is vulnerable to traditional car makers finding the popular better value products that fight back against Tesla in the battle for electric car market share.

Even more extreme is the price behaviour of Bitcoin. This has proved a great gambling counter for those who want a flutter and can afford to lose a lot of money in a hurry. Right-timed buying and selling means the fast and furious advances in price can produce good winnings.

Bitcoin soared above $41,000 on 8 January, only to fall by a quarter by 11 January. It has had similar runs and tumbles before. In December 2017 it was close to $20,000, only to collapse to under $4,000 a year later.

Bitcoin is not a functioning currency and has its enemies amongst the central Banks and regulators. Nor is it an approved investment for many portfolios given its nature and large fluctuations. If there is to be a scarce low-inflation digital currency the governing authorities want to own and control it. It will after all be a competitor for the paper and digital sovereign currencies and the Euro that they offer us now.

All this speculative activity and exaggerated volatility tells us there is still plenty of cash around looking for a home at a time of ultra-low deposit rates. It also tells us some people are playing with money they do not have or are taking excessively risky positions, which they may need to cut in a hurry if the price of their chosen counter turns down. All this noise makes longer-term sensible investing a bit more difficult.

What to do?

Let us take the big issue of the day. Should you now have more in markets and shares that will benefit from a recovery in traditional businesses damaged by the pandemic – or in the longer-term strategic winning areas such as the digital and green revolution stocks?

As we flagged a little while ago, the one-way bet to concentrate just on the winning areas is over. Index investors need a bit more balance and share selectors can find winners amongst the scarred sectors as well as losers amongst the long-term growth areas. It’s a time for more nuanced and researched answers.

There are some extremes in valuations that will not come right based on likely future changes of earnings and dividends in both categories. There are also new patterns and threats. This week we have highlighted the problems of Twitter and Facebook. More regulation and more responsibilities as publishers will raise their cost base, whilst putting off or banning millions of their followers by censorship will cut their growth in users and advertising revenues.

The bigger issue is it still safe to hold shares, given the extended valuations?

For the time being, it should be, but it is probably a good idea not to be too greedy this quarter. Many would settle for modest single figure real returns this year given the circumstances. If shares go up too far too fast it will be tempting to bank some of that. The bond market in the US is reminding us there is a big lot of debt to finance at these tiny interest rates.

View Article – published by Charles Stanley on 13th January 2021