Peter McGahan: What now for stock markets?

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GLOBAL stock markets have been wild again, and I’ve had a few calls to explain where we stand. The news has a lot to answer for by creating fear and this toxic fear can help you lose more than your head.

When it comes to Brexit or covid concerns, the headlines rampaged through the markets, only to recover very quickly, while the inexperienced investor withdrew his capital and had to buy back at a higher price.

Noise is just noise, and the skill is having a steady hand on the tiller and being able to see through noisy data.

Consider the sound of Cineworld, the second largest movie theater chain in the world action. In April 2020, about to enter lockdown, the price hit 36p.

Less than two months later it had skyrocketed to 92p (155%) and in March 2021, deep in several lockdowns and social distancing, its price reached 122p (238% in 11 months). Where was the logic behind that?

A little over a month ago, I wrote about all the historical headlines that would have knocked your shirt off acting on such noise.

As always, looking at reliable data pays dividends. While Biden and others blame Russia for markets and inflation, that is simply not true.

As Hans Gosling noted, this blaming instinct focuses us on obsessing over finding a culprit to hit, and once we have that, we stop looking elsewhere, compromising our ability to solve the complex problem. It’s a strategy.

Biden’s statement about “Putin’s price hike” is repeated over and over on the basis that it will come true. It’s not true. Inflation was well on its way before that and just pushed by the war.

The winners have been oil and commodities, with the commodity index up over 60% year to date, and of course value stocks, which we mentioned in this column ago more than a year as a hedge against inflation.

Indeed, the MSCI UK index is also one of the very few markets to produce a positive return, largely because it has a 52% weighting in good old value stocks, unlike the US which are closer to 25%, hence its underperformance.

Prior to the referendum, the UK stock market was trading above its average relative to the rest of the global stock market excluding the UK market.

Since then, it has traded significantly below that level and is trading at a steep discount. It is therefore by default a more attractive market for investors.

This comes after the worst drop in GDP in 2020 of 10%, last seen in the great freeze of 1709, which I am sure you will all remember.

Despite the merchants of doom, certain facts remain. As you can see the oil companies aren’t the only companies getting a fair amount of money out of us, such is their pricing power, and that pricing power is reflected in their forward earnings per share on a year.

The chart showing the global equity index alongside earnings per share shows that the lines are nearly correlated until this year, when the index plunged but earnings per share accelerated. That’s why companies are seeing record profit margins globally.

Inflation in advanced economies is expected to return to around 3.1% in 2023 and real economic growth is expected to reach 3.6% in 2022 and 2023.

As we’ve said in this column over the past two years, value stocks perform best in inflationary environments. People need the things and services they have. Growth stocks are very sensitive to interest rates, which move north.

Another hedge (protection against inconvenience) is gold.

Looking back over the past 50 years, a 60/40 portfolio of stocks and bonds would yield a return of 9.7% per year.

If, however, you have diversified only 10% to have a 55/35 allocation of bonds to equities and 10% gold, the return increases to 9.8% with a significant reduction in volatility.

And so, you have better returns with less risk. Happy Days.

Not all funds are actively managed as above, so keep them informed.

Peter McGahan is managing director of independent financial adviser Worldwide Financial Planning, which is authorized and regulated by the Financial Conduct Authority. If you have a financial question, call Darren McKeever on 028 6863 2692, email [email protected] or visit wwfp.net

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