Neil Woodford, the UK’s most famous fund manager, has warned that recent stock markets rises are being driven by sentiment and momentum and draws a comparison with the dotcom bubble years.
The FTSE 100 has closed at a record high for 11 days in a row, a feat never managed before. But is this a sign of good times or a sign of markets that have got carried away?
It may not have seen record highs achieved with quite the frequency seen in the last three weeks, but during the late 1990s the FTSE 100 moved into record territory with such frequency, that many began to take it for granted.
But then it all ended in tears. The index peaked with a value of 6,930 on December 30 1999, tech stocks crashed, then we saw a wider stock market crash. 18 months or so later, the FTSE 100 was languishing at level that was almost half the 1999 record. Recovery was slow too, in 2007, the index went close to the record, but crashed again in 2008. The 1999 record wasn’t broken until April 2015.
And while it is great to see the index hitting highs with regularity, don’t forget, the latest record set last night of 7,292.37 was only 300 points or so above the high set 17 years-ago. Judging by the very slow crawl upwards seen this century, you might say it makes no sense to call the recent rises a bubble.
But Neil Woodford is a value investor, he looks to buy into stocks pertaining to good companies but which seem on the cheap side.
And he reckons recent gains have got nothing – or at least little – to do with the reality of how much money companies are making
He said; “Much of what we saw in 2016 does not appear to be grounded in fundamentals. In the long run, fundamentals are all that matter for share prices, but over shorter periods, they can be overtaken by other drivers, such as sentiment and momentum. That appears to have been the case in 2016 – market leadership has become increasingly concentrated in a handful of stocks, most of them commodity-related.”
It boils down to why stocks have done so well.
There are three reasons for optimism.
Reason number one: commodity prices have been rising, and since a lot of energy companies and miners make up the FTSE 100, that is good for the index but not necessarily good for UK plc.
Reason number two: the fall in the pound has had the effect of boosting foreign earnings of companies listed in the UK but which generated a large chunk of income abroad, once those earnings are converted into sterling.
Reason number three is that recent Purchasing Managers’ Indexes tracking the UK economy and indeed the US and Eurozone have been good, pointing to reasonable economic growth in the year ahead.
But Mr Woodford worries that many of the companies that have enjoyed share price rallies are not as strong as is generally thought.
He cites as an example Royal Dutch Shell which saw share prices rise by a half last year while consensus projections for the earnings fell by 34 per cent.
If the oil market is turning, as many think, this may indeed justify rises in the FTSE 100. But there are reasons to think that actually the oil price is likely to be flat for some time.
Mr Woodford said: “You could argue that the performance of the oil & gas and mining sectors has been justified by fundamentals, given the increase that we have seen in commodity prices over the last twelve months. We are not convinced by that argument, however. Perhaps these sectors (and the commodity prices upon which they depend) fell further than they needed to in 2015 but the recovery since then, in our view, goes way beyond what fundamentals would justify, particularly when you consider that many key commodities remain structurally oversupplied and the global demand outlook is still very poor.”