— Aug 25, 2021


We have been optimistic about the potential for returns from equities for a long time, reinforcing that view by adding to our positions significantly during the plunge in global stock markets last year triggered by the pandemic.

As stock markets have marched relentlessly upwards this optimism has faded. Assets have moved seamlessly from under-priced, to fair value, to fully priced, to expensive. Some parts have gone beyond expensive to “bubble” valuations – a price that cannot be supported by rational analysis but is the product of a stampede to own it simply because you believe others like you will push it higher still.

There is evidence of bubble valuations in multiple locations right now and our sunny optimism has been replaced by nervousness, especially for developed country stock market valuations.
Every significant peak in bull markets is marked by a mania that grips investors’ imagination (and wallet).

We are old enough to recall that it was penny stocks in the run up to black Monday in 1987, when shares in the UK and US fell by 25% in a single day, technology stocks in 2000 leading to a 50%+ bear market and lastly the housing market leading up to the Great Recession and banking crisis of 2008/9.

Today it is extreme technology stock valuations, cryptocurrencies and meme stock speculation by an ill informed American public, bored during lockdown and often using government stimulus money to fund this new found hobby.

Jeremy Grantham, the world’s preeminent expert on financial bubbles, says we are in another one. We believe him. However, knowing when you are in a bubble is one thing, knowing when the bubble bursts is another and bubbles usually grow well beyond what you consider implausible before they burst.

The famous phrase attributed to John Maynard Keynes immediately springs to mind in that markets can stay irrational longer than you can stay solvent. One can be wrong by a year or more and miss out on the (on paper) gains that are usually extreme just before the bubble bursts.

It is also emotionally difficult for investors, to have acquired defensive assets and to have sold assets that are soaring in value. Every story about further stock market gains inflicts a little twinge of regret because you are not fully participating in it. But successful investing requires discipline and to master the emotional biases that lead to bad decisions. Buying assets when they are overpriced is by far the easiest way to lose money and when it is our responsibility to protect and grow your wealth it is important to stay cool-headed.

One phrase Jeremy Grantham mentioned in a recent interview struck us as being particularly pertinent. In answer to the timing issue and what might constitute a signal that the bubble is at its zenith and about to burst, he stated that it was when the conditions for equities was near perfect: low interest rates, plenty of cash chasing stocks higher, profit forecasts being revised upward and little on the horizon to darken the outlook.

This was almost indistinguishable from a market commentary we read the previous day: “low bond yields, strong economic growth and accommodative central banks have created near perfect conditions for risk assets”.

We have been reducing your exposure to equities and building up protection against the two biggest risks to your wealth on the horizon: a bear-market (where there is a more than 10% fall in equity valuations) and inflation. We have continued this process and have further lightened our exposure to said risk assets and intend to do so again should markets move higher, whilst remaining vigilant to take more aggressive action if the outlook deteriorates further.

Should risk assets continue to rise in value then it means that, while your portfolios will continue to rise, we are likely to underperform the benchmark (which is taking more risks than we believe is currently prudent). Should we have a market correction then we will not be able to prevent all losses in your portfolio but what we will have is a growing proportion of cash and defensive assets that we can use to buy risk assets at much lower valuations. In this circumstance we would expect to outperform the benchmark by some distance. This is our philosophy for protecting and growing your wealth.