Written by Tony, 02 November 2018

There are plenty of things to worry about in the world. Of that I’m sure you don’t need to be reminded, and if you do, I am happy to leave it to others.

Among many other anxieties are asset prices in general, and the stock market in particular. There is now a consensus view that, following the longest bull market in history (a bull market is where share prices go up by more than 20%, and a bear market is one where prices go down by more than 20%), shares, together with all other asset classes, look over-valued. Gradually rising interest rates will squeeze the life out of this already ‘long-in-the-tooth’ bull market. Money will get harder and more expensive to borrow. There is more debt in the world than there was at the time of the Global Financial Crisis (the Crisis) a decade ago. Cue a repeat of the Crisis – or worse.

This blog will challenge that consensual view.

We believe that many assets, mainly shares, are actually – and demonstrably - very cheap today. Our viewpoint is that of a UK fund manager who also invests internationally. We aim to produce an attractive income for investors, and to grow that income over time. This task appears to us a good deal easier today than it has been for many years – and it’s getting easier by the day.

If it’s really true that the shares we’re interested in are as cheap as we think they are, then why can’t others see the value that we do? It’s an important question, and I will attempt to answer it as we go on.

We think that the experts have correctly spotted an animal, but they have mis-identified it. What we’re confronted with in October 2018 isn’t an aged and expiring bull, but a rampant bear. This bear market is already well-established in many sectors, where it has, in our view, more or less run its course. In the final stages, which have just begun, the bear market has begun to challenge those sectors, such as growth (particularly software and services), and the ‘bond proxies’ in sectors such as consumer staples and healthcare, which have been such favourites over the last decade. Today’s growth stock sell-off is confusing for investors, as the growth sectors have been safe havens from the various squalls that have hit financial markets since the end of the crisis. Now they are falling faster than anything else.

Value investors such as ourselves, who don’t invest in ‘growth’ or ‘bond proxies’ because they are still significantly over-valued, can take comfort from the fact that our bear market has been going on for a long time already. It will end as all bear markets do, and probably before all the things we’re worrying about (Brexit, trade wars, rising interest rates and so on) have ceased to be problematic. All we need to do is stay calm and enjoy the generous and growing dividends that our companies pay us. The value that we know is there will be realised in due course.

How we got from there to here

As background to today’s market, I’d like to revisit the history of the last two decades. This is a significant period, because it’s a period during which the UK stock market, as measured by its best-known 100-share index, has gone precisely nowhere. On the last trading day of 1999, the index closed at 6930, a record high. At the moment of writing, on October 30th, 2018, this hundred-share index is at 7009, a gain of just 1% in almost 19 years (source Financial Express). Since 2000, the market has halved, recovered, halved again, and recovered again to a new high. The roughly 10% drop of the last few months has taken the index back to its starting position.

In the last 19 years inflation, as measured by the RPI, is up 70% (source, the Office of National Statistics). The stock market has failed to protect investors against any of this inflation.

In 19 years, dividend payments from the UK stock market have risen from £38bn to £91bn (source Factset). In theory, rising dividends lead to rising share prices – but not in this case.

In 19 years, the UK economy, despite its roughly 5% contraction in 2008-9, has grown by 51%. (source ONS). None of this economic growth has been reflected in share prices.

This isn’t a bull market by any stretch of the imagination.

If it’s true that some shares have done very well, then it must also be true that an equal number have done very badly, as the aggregate return has been zero. And we don’t have to look very far. The UK’s two largest companies in March 2000 were the telecoms giants BT and Vodafone. BT’s share price was £16.00 then, and is £2.40 now. Vodafone’s was £ 4.00 then, and is £1.50 now. Both companies were market darlings in 2000, and are heartily detested today, despite being arguably better managed.

The period 2000-18 makes sense only if we look at it as a prolonged correction, or bear market.

At the beginning of the period, shares were everyone’s preferred asset class. In the late 90’s, company pensions and other institutional funds used to invest 55-60% of their portfolios in shares. Today, the proportion is more like 20%. In the late 90’s an insurance company called Scottish Equitable used to offer investors a ‘high equity with-profits fund’, in other words a safe fund for retail investors paying annual bonuses, but with performance supercharged by a high allocation to shares. This product was withdrawn soon after the 2000’s bear market began, and has not reappeared.

Since 2000, investors have developed a culture of risk-aversion. Making money is far less important than not losing it. This is classic bear-market thinking. The phrase ‘risk assets’ didn’t exist in the 1990’s. In 2000 there were no absolute return funds. Today, there are many to choose from, many of them very large. The great attraction of an absolute return fund is not the money it makes you, but the money you aren’t going to lose when ‘risk assets’ collapse in the next recession/crisis. The stock market has halved twice in recent memory, and many people think it’s on the verge of doing so again, so naturally the idea of investments with ‘limited downside risk’ is attractive. In practice, the protection given to you by absolute return funds may be less than you imagine. One of the oldest, largest and best-known of the retail absolute return funds has lost 7.5% since January 24th, so returns have not been quite as absolute as investors had been led to believe. What the fashion for absolute return funds demonstrates most clearly is the bear market thinking which has become so natural to most investors that they no longer notice it.

Bear market behaviour extends to the way in which listed companies are managed. Companies have to make themselves attractive to shareholders by paying large and growing dividends. Rather than being grateful for the income, investors worry that the companies can’t afford these payments, and will end up having to cut them. As share prices in all but the darling sectors sag, companies buy and cancel their own shares with a view to supporting the price of what remains. Investors don’t see this practice as a consequence of their own risk-aversion, but rather as self-seeking behaviour on the part of management. It’s often pointed out that executives are incentivised to grow the earnings per share of their companies, and the easiest way to do that is to reduce the number of shares in their companies, so that the profits attributed to the remaining shares will be higher.

Investors in quoted companies have become so demanding that increasingly companies don’t list. There has been a steady increase in the proportion of companies owned by private equity, compared to those on the listed market. Valuations for companies in private equity are higher than those for equivalent quoted companies. The growth companies favoured by private equity don’t normally pay dividends, so many private equity funds manufacture dividends by simply handing investors their cash back on a quarterly or half-yearly basis, as studies have shown them that this is what investors want.

Paying high, growing dividends has had only limited success in overcoming investors’ unwillingness to invest in shares. In 2000, a cash deposit account paid more than twice as much income as the average share. Today, shares pay on average four times as much as cash. But in 2000, investors were far more willing to buy shares than they are today.

The crisis of 2007-9.

The crisis of 2007-9 was a deeply traumatic event. It was a banking crisis caused by a gradual build-up of debt over several decades. The excesses went largely unnoticed, as they had developed over such a long period, until suddenly the world’s banking system was on the brink of collapse. The authorities decided to rescue it, by cutting interest rates to zero, and by supporting the market for government debt. These actions made it easier for governments and companies to borrow money, but made the debt thus created too expensive to be attractive as an investment, while removing all the benefits of saving in a deposit account. The underlying idea was to encourage investors to support the kind of companies that help the economy to grow. However, this effort was only partially successful. ‘Safe’ assets recovered, while ‘risky’ ones didn’t,

Defensive quality

The crisis cast a long shadow over the financial markets. Today, investors continue to show a marked preference for assets which performed relatively well during the Crisis, while avoiding ones which didn’t. Investors prefer ‘defensive’ companies, whose products and services remain in demand during a recession, such as pharmaceuticals, to ‘cyclical’ ones such as housebuilders. They prefer companies which don’t borrow money to those which do, and ‘quality’ companies which can make higher margins on their sales to others which make lower margins. The premium which investors are prepared to pay for these superior assets has continued to grow over the decade, and is now unusually wide.

Growth stocks

Since the Crisis, investors have been prepared to pay almost anything for the shares of ‘growth’ stocks – companies which are able to grow their earnings faster than the underlying economy. It is often said that during times of low economic growth, it makes sense to pay a premium for those rare assets which can grow faster. We owned a number of these companies in TB Wise Multi-Asset Income, but their prices shot up to a level well above our estimate of their value, so we were forced to sell them in the middle of 2017.

One example is Renishaw, a specialist manufacturer based in Wootton-under-Edge, and one of the UK’s undoubtedly world-class companies. We bought Renishaw in early 2016, paying around £16 per share. A year later, we sold the shares for around £25, but we sold them too early, for by July this year, they had more than doubled to £57.50. Today, three months later, they are £36.60, down over 35% from the peak, and apparently in free-fall. There has been a bubble in growth shares, and in today’s sell-off, it’s the growth shares that are falling fastest.

Momentum investing

Most investors, in our view, are momentum investors. It always feels good to buy something that’s been going up, especially when respected experts are telling you why it will inevitably go up further….and then it does. There’s nothing wrong with this, until eventually the momentum assets take on a life of their own, and the prices outstrip any reasonable estimate of the underlying value. Even then, momentum can continue far longer than you could possibly believe. The price chart tends to steepen until it’s rising almost vertically. This is the time of greatest risk, while feeling like a time of almost no risk.

Why it’s hard not to be a momentum investor

One thing that propels asset prices upwards is the knowledge that their prospects are improving. A property in a location that’s just becoming fashionable, for example, or a company that’s rapidly growing its profits. The value may look pretty full at the moment, but the asset will grow into that valuation, and in a few years’ time it will start to look cheap.

By contrast, asset prices fall at times when their prospects look bleak. It may look cheap now, but in two years’ time, when the profits have collapsed, when the property is empty and no tenants can be found, then it will turn out not to have been a bargain at all.

In a nutshell, the most expensive assets often don’t look expensive, and the cheapest ones often don’t look cheap.

The growth investors are right, or nearly right. It makes sense to pay more for the best assets. But eventually there comes a point where it no longer makes sense, and we have reached that point.


A period of two decades during which investors have become increasingly disillusioned with shares has been a vintage period for alternatives. To find out what the smart money is doing, it’s worth taking a look at Knight Frank’s Luxury Investment Index. The 2017 edition tells us that over ten years, classic cars had made returns of 334%, fine wines 192%, coins 182%, jewellery 138%, and stamps 103%.

We discover that ‘a strikingly small and simple 1000-year-old Ru Guanyao ceramic brush-washing bowl…fetched almost $40m’ while Paul Newman’s Rolex Daytona sold for $17.8m.

The KF Luxury Investment Index rose strongly through the financial crash.

The taper tantrum

In May 2013, Ben Bernanke, the Chairman of the US Federal Reserve, announced that the ‘Fed’ would soon begin tapering (i.e. reducing) asset purchases under the QE (Quantitative Easing) programme. This was the first step taken by any of the world’s central banks towards normalising monetary policy after the unprecedented stimulus made necessary by the Crisis.

Gradually, the Fed has ceased QE altogether, and has been raising interest rates for the last couple of years. As usually happens when a country’s central bank raises interest rates, the currency (in this case the dollar) rose, causing a panic in most emerging markets, and a sharp fall in their share prices and currencies, which became known as the ‘taper tantrum’. Emerging market asset prices have not yet recovered to the levels they were before the announcement.

China is the largest of the emerging markets. Its stock market, measured by the MSCI China index, peaked at 100.3 in October 2007, and again at 98.6 in February this year (source Financial Express). Today’s level of 68.48 is more than 30% below both of these peaks. Investors are worried because China’s economic growth rate has slowed down to ‘just’ 6.5%. China’s economy is more than twice the size it was when its stock market was almost 50% higher than it is today.

Are all asset prices expensive?

We think not. When commentators tell you that ‘all asset prices are expensive’, what they really mean is ‘there are two kinds of investment – ones we’d consider investing in, and ones we wouldn’t. The assets we’d consider investing in are expensive, and we don’t know about the others, because we don’t bother to look at them’.

As Warren Buffett puts it ‘You pay dearly in the market for a cosy consensus’. Now you don’t have to. We believe that this may be an unusually rewarding time for those prepared to go a little way off-piste.

Is it partly an age thing?

The last time UK investors saw a real bull market top, in which all share prices were significantly overvalued, was in the late 1990’s. If you were managing money professionally then, you would have to be at least in your mid-forties today.

What ended the stock market recovery in 2007 was not excessive valuations so much as the failure of the banking system. The growth stock bubble, which entered its final, euphoric phase a couple of years ago, and is ending now, is more like the last 90’s peak than anything that has happened since. But most people don’t remember it.


The period since 1984, when I became a financial adviser, can be divided into two unequal halves. From its inception in January 1984 until the end of 1999, the UK’s 100-share index rose from 1000 to nearly 7000, in a period of sixteen years. From January 2000 until the present day, it has gone - nowhere.

It follows that there is a lot more value in the UK market now than there was in early 2000, and that the potential for returns is better today than it was then, even though it may not feel like that. It also follows that the vast majority of investors and commentators were optimistic at the end of 1999, following two decades of great gains, just as the vast majority are pessimistic today.

In 1999, when shares were expensive, a wise investor would have avoided them. There was a perfect alternative to hand, in cheap, high-yielding government stock. Today, there is an equally obvious alternative – the cheap, overlooked ‘risk assets’.

Our suggestion is, please don’t make the mistake that others are making – don’t get the wrong animal. We have been in a long bear market, so long that many people can’t remember anything else, in sectors such as retail, banking, insurance, construction and telecoms, and in much of real estate. Bear markets don’t last forever. This one is already ‘long in the tooth’, and it is now in its final phase – a sharp derating of the ‘darling’ assets of the past decade.

This last year-and-a-half, spanning the final phase of the growth stock bubble, has been an unusually difficult period for us value investors. We believe better times may be ahead.

Tony Yarrow

Fund manager

October 30th 2018

Please note – this blog contains the personal opinions of Tony Yarrow, and is not intended as financial or investment advice.

Tony Yarrow has managed investment funds since 1988.

Subscribe to our newsletter

Register to receive regular market views and commentary from our investment team by email