The small stuff doesn't matter in the turn of equity markets says Legal & General
In today's Fundamentals briefing, LGIM equity strategist Lars Kreckel discussed the difficultly in predicting the end of bull markets. With many equity indices at all-time highs, Lars examined how bull markets have historically become a bear market and how equities have behaved in the later stages of a market cycle.
After six years of the current bull market, many investors are nervous about when the party will end. LGIM research showed that contrary to popular belief, the length of the bull market and valuations are not good indicators.
"So if it's not old age or overvaluation that ends bull markets, what does? Both these notions imply that bull markets will eventually just collapse due to their own limitations and we think it's more useful to think about the events or catalysts that trigger a bear market" said Lars.
A concrete driver of bull markets is expansionary economic cycles – and there's a clear link on the downside too, with bear markets coinciding with economies moving from growth to recession. Looking closely at the periods around the start of recessions shows that equities tend to fall in anticipation of the recession. On average, the peak in equities occurred about six months before the start of a recession.
"Another dynamic that often coincides with recession is the reduction in credit availability. Generally, tighter credit conditions are seen by a flat or inverted yield curve. Indeed, seven of the past eight bull markets ended around the time when the global yield curve was flat or inverted, with the 1987 'flash crash' the standout exception. Like recession, tightening credit conditions are not a necessary condition for a significant equity market correction, but they certainly make it more likely" stated Lars.
"Three key factors drive our medium-term risk taking: the economic cycle, valuations and the probability of a financial crisis. Focusing on these factors allows LGIM's asset allocation team to concentrate on what really matters, ignore the noise and benefit from the bull market that started in 2009. When a news event or new situation arises, we ask, can this factor trigger a recession? If the answer is 'no' or 'low' then our positive mid-cycle view should prevail" finished Lars.
For the full article, please click here: May 2015 Fundamentals (PDF, 1.1 MB)
NOTES TO EDITORS
LEGAL & GENERAL INVESTMENT MANAGEMENT:
Legal & General Investment Management (LGIM) is one of Europe's largest institutional asset managers and a major global investor. LGIM manages £708.5 billion in total assets for more than 3,000 clients*. Throughout the past 40 years we have built our business through understanding what matters most to our clients and transforming this insight into valuable, accessible investment products and solutions. We provide investment expertise across a full spectrum of asset classes including equities, fixed income, commercial property and cash. Our capabilities range from index-tracking and active strategies to liquidity management and liability-based risk management solutions.
*As at 31 December 2014
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