The Greater Fool Theory

The Greater Fool Theory

After the longest US bull market in history, some caution should be taken on valuations.

Although some may quibble over which yardstick to use, the US bull market has now – by common definitions – passed the 3,454-day threshold that makes it the longest on record, beating the climb between October 1990 and March 2000. And, at the time of writing, the S&P 500 has, at least temporarily, breached its previous all-time high – set on 26 January. Bring out the champagne flutes you say? Well, to borrow some wisdom from one of the world’s most famous investors, this is not the time to be greedy.

For those who haven’t paid attention, 2018 so far has been all about US stocks, which despite the wobbles in February and March, have significantly outperformed other markets. This divergence is not without reason, as the US has continued to post robust economic data and gangbuster corporate results.

By contrast, the tone in Europe has turned pretty sour, what with trade tensions, the growing risk of a no-deal Brexit, Italy’s new anxiety-inducing political scenario or Turkey’s mounting woes (the latter two being of particular consequence for the region’s banks). And, for their part, emerging markets have come under the cosh, in no small measure due to the strengthening US dollar.

 

We are moving into a market environment where investors need to be more discerning.

Analysis by Bloomberg shows the percentage of non-US stocks that have entered bear market territory (i.e. falling 20% or more) heading northwards at fairly a rapid clip. This percentage sits at around 28%, versus 8% for the US – the calculations are taken from Bloomberg’s own ‘World Index’. The glass-half-full take on this is that, on a relative view at least, many non-US businesses are no longer priced for perfection – which matters greatly to investors that obsess about margins of safety, like ourselves.

Against this backdrop, we have seen a shift in the market’s preferences. Value stocks have been working better, as has high-dividend yield (as a value style), since the beginning of June, particularly in Europe, but more recently also in the US. This has manifested itself in cyclicals such as materials, industrials and financials all lagging some defensive areas such as healthcare and consumer staples. Tech continues to do well – but it's predominantly a FAANG (Facebook, Amazon, Apple, Netflix and Google - but less so Facebook and Netflix which have taken a pummelling of late) story still.

All bull markets eventually turn into a game of ‘greater fool’, and while we do not waste time trying to call the exact inflection point, we believe a modicum of caution is required. This year, we have favoured utilities in anticipation of a market leadership change over financials and some other more cyclical businesses. All in all, we believe we are moving into a market environment where investors need to be more discerning, which suits our long-term, high-quality approach very well. 

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