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Global stock markets are close to record highs, valuations look stretched and investors are nervous. Is a major crash around the corner?
Professional investors are certainly worried: 44pc think stocks are overvalued, according to a global survey of fund managers by Bank of America Merrill Lynch. That’s the highest figure on record.
On one metric, the cyclically adjusted price to earnings ratio or “Cape”, today’s valuations have been surpassed only during the build-up to the Wall St Crash and the dotcom bubble.
But investors inclined to bail out now face a thorny dilemma because the period immediately before a crash is when the best returns tend to be made.
Before the past 10 major crashes, the average return in the preceding 12 months was 27pc while in the preceding two years the average return was 39pc, according to JP Morgan Asset Management.
Here are five reasons why the markets are not about to crash.
1. The global economic recovery isn’t over
The economic recovery following the 2008 financial crisis appears to remain on track.
America – whose stock market sets the tone globally – is furthest ahead in the recovery cycle. Unemployment is still falling, albeit more slowly, and consumer confidence is still growing.
Veteran fund manager Richard Buxton of Old Mutual Global Investors said: “As long as the US economy continues to be supported by growing employment, the post-financial crisis healing process is still going on.”
Globally, he said, consumer confidence is at a 17‑year high.
“You can always point to risks: the famous China slowdown, North Korea and more. But as long as that healing process is continuing, I’m optimistic about markets,” he said.
“If you saw a rise in US unemployment month after month, that would make me cautious.”
He added that the recovery had only recently gained traction in Europe, where it has much further to run, meaning greater potential for investors.
An economic index that has proved a particularly good predictor of previous American downturns also remains positive, said JP Morgan Asset Management’s Nandini Ramakrishnan.
Produced by the Conference Board, a US research group, the index combines a host of metrics in areas such as unemployment, manufacturing orders and consumer confidence.
Ms Ramakrishnan said: “This index is continuing its gains. One catalyst for a crash in the US would be a recession, but the risk of that this year is subdued.”
2. Central banks won’t let them
A major source of support for the financial markets during the recovery from the financial crisis has been central banks injecting cash by “printing” money.
The unwinding of this practice does pose a danger to markets, according to the Manchester & London investment trust.
“There are many exciting reasons the market could fall, like a Korean war, but the unwinding of central banks’ money printing is the highest probability catalyst for a weaker stock market,” the trust’s manager, Mark Sheppard, said this week.
However, central banks are well aware of this risk, and any change is likely to be gradual. Mr Buxton said: “Central banks are going to remain incredibly supportive and will be gentle in how they remove stimulus. The European Central Bank is still printing money as we speak.”
3. Company profits are growing
In all major markets, company profit forecasts paint an optimistic picture. The profits of companies in the MSCI Global index have been flat for the past seven years but are now growing again, according to Bank of America Merrill Lynch.
Phil Haworth, deputy head of equities at investment firm Kames Capital, said: “The profit picture is encouraging. For it to send share prices higher it needs to translate into higher spending by companies on investment, employment and so on. Survey data supports this happening.”
4. Cash is already sitting on the sidelines
Nervous investors, both private and professional, have already sold some of their shares in favour of cash.
According to Merrill Lynch’s fund manager survey, asset managers now have 5pc of their assets in cash, compared with an average of 4.5pc over the past 10 years – a periods that includes the 2008 crash, when many held large amounts of cash.
Mr Buxton said that on a recent tour of the country to meet investors, the one defining feature, “to a man and woman”, was that individual savers were sitting on cash and hoping for a market fall to be able to invest it.
If these investors pile in when markets fall, the correction is likely to prove brief.
Mr Haworth said: “Some might argue we are overdue a correction in stock markets, but this would be a dip that should lead to investors taking the opportunity to buy.”
5. Investors aren’t ‘irrational’ yet
During the build-up to the tech crunch, soaring share prices, and consequent unjustified valuations, had the effect of drawing more people into the market. Many previously cautious investors threw caution to the wind and bought dotcom stocks indiscriminately.
Today, that isn’t happening. Merrill Lynch said there was “no irrational exuberance” driving stock markets to unsustainable levels.
It could be argued that parts of the technology market are again overvalued, but at least this time round the firms concerned, such as Google and Facebook, have customers, revenues and profits.
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