Processes always Win!
Following a set investment process is essential to success; hoping to analyse financial markets in depth is becoming increasingly difficult (if not impossible) as information constantly changes.
To overcome this as with any complex problem the best solution is often a simple one – we find that using a process of identifying when and how much risk to take on with key rules removes the risk of human behavioural errors.
Below is a list of what we look at; you don’t need to know the nitty gritty of all this but it should give you an idea as to how they allow us to build a framework for a decision.
- The UK is currently at above average risk levels looking at the percentile rank
- Valuations remain extended at near 5 year highs, the prolonged bull market has seen 5 year lows jump higher
- The index is above its 200 day SMA that is considered supportive of prices
- The McCellan Summation Index is showing signs of divergence and suggests weakening market breadth
- The RSI is giving very little away and remains in neutral levels
- Investor preferences remains for stocks as over three months they have outperformed Government Debt
- Over 70% of stocks have EPS above their 10-year average
- Corporate Profits are above their 10-year trend
- Over half the stocks in the index are trading above their long term average PE
- None of the stocks are more than 40% below their 5-year maximum PE
- The CAPE ratio at 14.2x is below the 16x minimum
- Market Cap to GDP is above average but nowhere near the peak of 150% in 2007 or 200% in 1999
- The UK Government and Households remain heavily indebted
- PMI sectors are continuing to show expansion but do not tend to remain around the 55 level for too long
- The ZEW indicator has only recently rebounded from its lowest levels in the last 30 years
We would currently consider the UK Equity Market as in a stage of above average risk with steep valuations; however investor preference remains skewed toward risk assets as they outperform Gilts and the 200 day SMA may continue to be supportive of a market that has exhibited some additional volatility in recent months. Whilst PE ratios may look average and the CAPE attractive at below 16x earnings risks appear to exist as Corporate Profits are above trend and continue upwards indefinitely the possibility that earnings will fall rather than prices rise is considerable.
Economically the country and individual has a high level of leverage and only ultra low interest rates, and until now benign inflation, have protected households from potentially difficult times. Leading PMI Indicators could be peaking and a reversal in confidence could easily occur – the ZEW indicator meanwhile shows the biggest divergence from the FTSE-100 that we have seen for many years which increases risk.
Whilst there are no obvious signs of value, and in fact plenty of risks, general support for the UK equity market could well continue suggesting that existing holdings should be retained; a decline in the indicators above would offer an opportunity to start a process of gradual investment.