Throughout financial market history, there have been occasions in which markets have become completely detached from valuation reality. We believe we are in one of these periods right now, with bubble-like characteristics increasingly evident and adding considerable risk to the investment backdrop. The elastic between the valuation of the popular stocks (such as the FAANGs* in the US, or in the UK, anything which offers investors exposure to Asian growth) and the unpopular stocks (anything domestically-focused remains completely out-of-favour) is now at breaking point, in our view.
We have already seen many signals to suggest that this valuation stretch is now starting to reverse: tighter liquidity conditions, pressure on emerging markets, slowing growth in China, vanishing momentum in the eurozone economy, along with the continued resilience of the UK economy – all point to a stock market which cannot remain in denial of fundamentals for much longer.
Timing a market reversal, or pinpointing a specific event that will trigger it, is not possible but neither is it necessary. It is an inevitable consequence of the way that financial markets work and have always worked. Ultimately, fundamentals are like a gravitational force that pull markets back into alignment with reality. That is why bubbles burst. Fundamentals always reassert themselves in the end and that is why they are the only things that matter in the long run.
* FAANGs stands for Facebook, Amazon, Apple, Netflix and Google (now Alphabet).