Are markets really heading for 30% crash?

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Are markets really heading for 30% crash?

Fear of rich US equity valuations persists, and that a big sneeze would mean everyone catches a cold. The latest guru to warn is Mark Mobius, an 81-year-old fund manager best known for having run Templeton emerging markets investment trust (TEM) He believes "all the indicators" point to a 30% drop in US equities, wiping out gains of the last two years.

Exchange traded funds (ETFs) - accounting for nearly half of all US stock trading - would amplify a fall as computers/algorithms create a snowball effect. "There is no safety valve to prevent further falls, and that fall would escalate very quickly."

He concedes that "if Trump's policies pay off then markets could move higher, but things are just looking so 'toppy'... and if the US market falls, then everybody is in trouble."

You may ask "yes, but when?" in response to persistent cautions like this, because if you'd heeded similar warnings you wouldn't have owned stocks since the 2009 crisis. Do they reflect sagacity or grumpy older men?

Although Sir John Templeton himself was an octogenarian money manager - ever the optimist - and Warren Buffett is plenty confident in US equities for the long haul, Mobius could be attention-seeking while poised to launch a new developing countries' fund, as despite hailing a downdraft he still reckons this is "a stockpickers' market".

Signs of bullish exhaustion creeping in

Encouragingly, over 80% of S&P 500 firms have beaten earnings forecasts in Q1 2018 versus 73% in Q4 2017, yet it is pertinent how the US market fell about 2% on 24 April. In part, this related to the yield on 10-year Treasury bonds touching a psychologically important 3% level, given higher bond yields are antithetical to rising share prices.

But various stocks also whipsawed despite reporting strong results: Caterpillar (CAT) initially rose 3.5% after declaring Q1 profit/sales well above expectations, then slumped 5.6%. It wasn't just cyclicals: Coca-Cola (KO) fell 1.9% despite slightly beating expectations.

If you recall Jesse Livermore, the celebrated early 20th century trader in Reminisciences of a Stock Operator, such stock behaviour was his cue to "put on shorts" in every sense, leave the market and go fishing.

Clarkson presents dilemma for global economy bulls

Perhaps the most significant trading update in April has been a sudden turnaround in expectations from shipping services group Clarkson (CKN), a proxy for economic activity outside the US, being geared to Europe, the Middle East, Africa and Asia Pacific.

In less than six weeks its outlook has deteriorated from "the first signs of a broader shipping industry turnaround" (at prelims) to a latest update: "challenging environment in shipping and offshore capital markets...transactions pushed back... have compounded a quiet period in sale and purchase activity...lower freight rates within the tanker market..."

Does this represent falling demand in a macro sense, or just short-term negatives conflating? Trade war noises in a fragile market for tanker rates coincide with sparse credit for shipping, also a lower US dollar - the industry's chief currency.

Despite downgrading 2018 earnings by 25% and 2019 by 15%, Clarkson's broker contends it due to "uncertainty suppressing transaction activity rather than a widespread reversal in freight rates"; yet this begs the question whether prices can withstand lower demand, also at what point it does all reflect the wider economy. Shipping can be a tell-tale leading indicator.

I've noticed the Baltic Exchange Dry Index - a proxy for dry bulk shipping activity - falling this year, though it has bounced in April. It's a notoriously volatile index, claimed variously in recent years to herald a slump, so I wouldn't flinch yet. Amber lights from the shipping industry still need watching. Global growth is chiefly behind investors' bullish outlook for 2018: a sense that for the first time in a long while, all the vital economies are performing strongly.

Mixed signals in the UK

That government borrowing fell £3.5 billion to £42.6 billion in the 2017-18 financial year to 2.1% of GDP, which is down from 10% in 2010, is welcome in a wider sense - e.g. potentially strengthening sterling which checks import prices and inflation and also may reduce government austerity towards support services and the like.

It's a glimpse "out the woods" if hardly an exit, given total public debt as a percentage of GDP has risen from 85.3% to 86.3% year-on-year, standing at £1.8 trillion. If you think a Corbyn government would be disastrous for investors and the UK economy, maybe this improves the Conservatives' standing.

But unless management at the AIM-listed Begbies Traynor (BEG) corporate insolvency/recovery group are Remoaners seeking any chance to vent frustration, their latest Red Flag Alert for Q1 2018 is not a good read - citing increased levels of financial distress across all sectors and regions of the UK.

Levels of significant financial distress are up 33% to 477,210 businesses versus end-March 2017, with London showing the most distress, up 42% to 119,419 firms. Those most affected across the UK are support services, up 40% to 60,541; construction, up 26% to 60,541; property, up 46% to 41,624; and telecoms, up 47% to 32,538. Notably, some higher-end services are also troubled e.g. professional services up 46%, financial services up 45% and automotive up 15%.

This is relevant potentially to recruitment and financial stocks, although company-specific updates are really needed. Nearly half a million UK businesses have been pushed into financial distress in terms of negative net worth and/or working capital deficit, though this probably reflects smaller private firms than quoted UK plc.

The UK economy is still predicted to grow about 1.7% this year, yet Begbies' findings are another aspect to watch as cyclical fore-warning. More positively, consumer price inflation has eased from 3.1% last November to 2.3% this March, although employment and wages are growing at the fastest rate in two years. When raising interest rates by 0.25% to 0.5% last November, the Bank of England guided for two more 0.25% rises over the next two years, capping the base rate at 1%.

Hopefully, sterling's fall post the EU referendum, hence its boost to import prices, is passed, as the worse-case scenario would be the Bank in a stagflation dilemma - unable to raise rates without causing grief to smaller firms. Sceptics might say, the problem goes back to QE and ultra-low rates allowing over-borrowed "zombie" firms to continue where the last recession should have finished them off.

Vague warning also from media sales

There isn't now a pure UK media-buying listed stock like there used to be years ago. I don't recall its name and it was too hard to predict earnings to be anything more than a short-term punt, but its updates were useful as a macro indicator. Thus, I pick up on Vitesse Media (VIS), an AIM-listed publisher and event-organiser, warning that reduced higher-margin media sales mean a higher loss than anticipated in January, for its year to end-March 2018. Vitesse is wholly UK-orientated.

It would be a "glass half-empty" view to major on such warnings as a turning point both in fundamentals and risk appetite, but if they multiply then, yes, they would trigger the kind of self-reinforcing sell-off in equities Mobius cautions about. The US economy appears overall strong. However, mind any trend in UK-listed firms cautioning, as if the corporate stress identified in Begbies' report is spreading.

Yet Credit Suisse argues "Buy UK equities"

This investment bank estimates the UK market ranks cheapest after Japan, in the bottom decile of its historic range and with its dividend yield at a 15-year high. Almost all sectors apart from industrials look unusually cheap both on price-to-earnings and price-to-book values, relative to global peers.

The analysts reckon on 2018 GDP slightly higher than expected; retailing stocks are extremely cheap; they also like big-cap oil and mining, tobacco and spirits. Just mind, such analysts' income is linked to promoting big-cap stocks.

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