Beware stock market complacency

By Neil Worsley, investment strategist, Hedley & Co.

The recent stock market pull-back should be seen for what it was, a healthy correction in a complacent stock market.

Investor nerves were set on edge as the US 10 year bond approached a 3% yield as alarm bells began to ring that inflation may not be dead after all and interest rates in the United States may therefore, have to rise sooner and higher than was first thought.

This spooked the financial markets where falls were compounded by the liquidation of some volatility funds, increasing the volatility index which led to further asset sales.

While no one can ever be certain that these short term fluctuations are now over, there are a number of factors which are still supportive, particularly of the stock market.

In the United States, where the stock market is usually a guide for other world markets, the market valuation is certainly not especially cheap compared to historic averages.

However, the recent tax changes there will certainly give a fillip to the economy and also reduce the tax element which many companies pay, giving a short term boost to profitability and earnings.

In addition, while February saw investors selling shares, companies spent $113bn buying back shares, the most since April 2015, a trend which is likely to continue. This move signals that companies will be ready buyers in any market slide.

On the economic front, there is healthy economic growth in most parts of the world, with employment levels improving and productivity growth rising.

While inflation has been subdued for much of the past 10 years, this is likely to be the main focus of attention over the coming months and years.

Provided that this remains contained then stock markets should continue to prosper, albeit with perhaps a degree of volatility which investors have not been accustomed to for some time, although neither the US equity market nor bonds would be our favoured home for investment. For regulatory disclosures, please visit www.hedleyandco.co.uk/publications and click on Hedley Regulatory Disclosures.