Called it

Some managers predicted we’d end up with the chaos we have today – but will they still perform well?…by David Kimberley

 
In 1997, PBS aired a documentary in the US covering the then hysterical rush to invest in the stock market, particularly among retail traders. A striking number of parallels with the past couple of years emerge when watching the programme. People discussing stock buys on internet forums, companies with no earnings seeing astronomical rises in their share price and attacks on anyone that questioned the wisdom of the whole craze.

What also stands out is the number of commentators in the documentary saying that what’s going on isn’t normal and is likely to end with a crash. Even though they were right, it took another three years for the Dot Com bubble to actually burst.

That highlights one of the frustrating dynamics that exists in financial markets. Spotting a bubble or saying that something is overvalued is comparatively easy. Predicting when that dynamic will actually play out, whether it’s a bubble bursting or something else, is much harder.

Looking back over the past decade, a number of fund managers have argued that valuations across asset classes have been fuelled by an unsustainable credit boom. With growth investors seeing their portfolios ticking up in value, it was easy to dismiss those claims. Doing so now is much trickier and it seems very likely the era of cheap credit and debt-fuelled expansion is over.

This was the line of argument that Gervais Williams, manager of Miton UK Microcap (MINI), made when we spoke to him earlier this year. Perhaps unsurprisingly given that he is an active manager, Gervais has argued that the end of the debt-fuelled cycle will provide more opportunities for active managers. There is, to be fair, good reason for this. Cheap debt gave a boost to companies across the board over the past decade, making passive investments more ‘logical’.

The past year has seen this unravel, as companies with no earnings or lots of debt have started to see massive hits to their valuations. Moving forward it seems much less likely that we will be in a ‘rising tide lifts all boats’ type of market.

Instead, companies with low or no debts, and which produce surplus cash, seem much more likely to be able to whether a tough economic environment or even take market share. In contrast, profit-less companies that have relied on a low cost of capital and ‘funding rounds’ to keep themselves afloat will struggle to survive.

Ruffer (RICA) is another trust with managers that had been warning about the largesse of the post-financial crisis world. Jonathan Ruffer, the founder of the asset management group that runs the fund, has been arguing for years that quantitative easing policies were unsustainable. He may have been early in making those predictions but it seems he has been proven right in the end. That RICA has held up so well this year makes his views even more compelling.

Saying that something like this would happen isn’t necessarily a sign that you’ll be able to make investment decisions to take advantage of it. Nonetheless, there is still something reassuring in knowing that a manager has been cognizant of these dynamics and is thus prepared, in some way, to navigate them. Whether or not that will result in returns for investors remains to be seen. It’s one thing to predict a crisis, another to actually benefit from one.
 

 

Disclaimer

This is not substantive investment research or a research recommendation, as it does not constitute substantive research or analysis. This material should be considered as general market commentary.
 
Past performance is not a reliable indicator of future results