Summertime and the living is easy

Here we are again: one year gone in a new UK equity bull market. I feel entitled to make the ‘bull market, again’ claim as much through experience as pure reasoning, albeit the latter supports the former and I’ll come back to the justifications of reason shortly.  Of course, markets are never devoid of risks, and it behoves investors to guard against complacency, but experience suggests it’s ‘summertime and the living is easy’ (82% of the UK’s ‘main board’ shares are up in the year to date)¹. 

The UK Equity team is perhaps entitled to make our bullish claims for two distinct reasons. First, because they are made only partially in hindsight. Indeed, we wrote in March last year about our belief that a new bull market had begun. Secondly, from the end of March to date, the Mirabaud UK Equity High Alpha fund has risen by over 100% (and the UK equity market by over 50%) and in this last detail the bull market is, ipso facto, true².

In fact, the UK market has risen by 50% or more on a rolling 12-month basis on only three occasions in the last 35 years³, so these are near unprecedentedly strong returns such that investors (in the Fund, or in our asset class more widely) will likely worry that the easy money has been made (indeed, it has) and presume that good judgement now favours taking profit (no, it doesn’t).  Experience tells us otherwise, rather instead to ‘buy the dips’ (and fundamentally the key point is that ‘buying the dip’ would be consistent with our stock-specific focus and insights on valuation, which, as ever, forms the basis of our decision making, not wider market forecasting, wherein our opinions are only ever deduced from stock specifics).

When it comes to explaining bull markets, Sir John Templeman said it best: “Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria”.  Clearly investors are no longer pessimistic, but equally in UK equities there are as yet very few signs, in aggregate, of euphoria (stocks collectively sum to attractive valuation even though inevitably some individually test the rule).  Moreover, the UK equity market’s relatively lacklustre longer-term performance when compared to other major equity markets implies that investors are still broadly sceptical about UK equity prospects (even though share prices of certain stocks have evidently recovered ahead of their current trading).  In other words, within Sir John’s framework, the bull market has at least one more phase to go and possibly two. 

In my career, I have managed money through the tail end of one bull market (that actually began in the mid-1970’s, in the aftermath of the first oil shock) and three complete major bull markets and through four major bear markets.  The 1970’s bull market was significant (returns were inevitably helped by the market’s ~70% capitulation in 1974 following the four-fold rise in the price of oil) but in broad-brush terms the bull run lasted for 13 years, with annual average returns of ~25% and it ended with the 1987 crash and ~36% market fall within weeks.  Then came the great bull run of the 1990s (again, a 13-year rising trajectory but with annual average returns of ‘only’ ~12%) which culminated in the bursting of the TMT Bubble in September 2000.  Indeed, arguably these two bull markets were in fact a single 26-year period, punctured by a severe correction (i.e. a 26 year ~15% annual average return bull market!)⁴. 

The bull market that followed the TMT bust (which resulted in a ~50% fall from peak to trough) was somewhat short and sweet relative to the two that proceeded it, lasting for almost five years with ~20% annual returns, before ending in the Global Financial Crisis (2007 – 9, another ~50% peak to trough fall).  Subsequent to the GFC in 2009 the UK market set off on another decade long bull run, lasting ~11 years with annual average returns of ~10% until ended by the Pandemic Crash (~-36%) a year ago, in March 2020 and the Covid caused recession⁵.

So, in summary of my bull and bear market experience, I’ve seen four bull markets where the third (sandwiched between the TMT Bust and the Global Financial Crisis) is the odd one out for being of ‘only’ five years duration rather than ten years or more, and four bear markets, two of which were actually crashes (1987 & 2020) and over relatively quickly and hence less painful. It needs acknowledging that the second and fourth bull markets were periodically punctured by ‘corrections’ (falls with their own catalyst, e.g. reverberations from the collapse of the Nikkei-225 bubble in 1990, the 1992 UK exit from the ERM, the ‘head-fake’ TMT bubble burst that presaged the real thing two years later, 9/11, the Brexit vote, etc) but ‘corrections’ stop short of capitulation and hence they don’t, per se, mark the end of a bull market period (which is why buying the dip they create becomes a wise course of action).

It is perhaps a little glib to state that each bear market ended the preceding bull market only to give rise to another (which is definitionally true if ‘down and up’ is not actually sideways – which is another perspective of the last twenty years of UK equity market history) but - and here I am finally getting to the point - the question most obviously begged by reference to history is where is the UK equity market today, in history (or in other words, what can history teach us)?  Only one fact is certain; that the current bull market is one year old, but as “history doesn’t repeat itself but often rhymes”, then why should investors not expect relatively undemanding UK equity prices to rhyme with history and rise, in aggregate, if not for the better part of the current decade, at least for a number of years to come?  Even if the ‘easy money’ has been made (because a market rise of 50% in one year could well equate to ~half the market return in effectively 20% of the time), if this was true it would still leave available more than a few years with attractive double digit annual returns that would be enhanced by ‘buying the dips’.

Indeed, as the domestic UK economic recovery in ‘crowd-space services’ gathers rapid pace, given the success of the UK’s vaccination programme and significant pent-up consumer demand (from enforced curtailed expenditure and resultant higher savings rates and the desire to make up for lost time) and as the recovery coincides with the acceleration in online economic activity - itself a robust engine of corporate profits growth throughout the pandemic - then is talk of history repeating itself with a second ‘roaring twenties’ so fanciful?

What is not fanciful is the idea that higher share prices should follow from relatively undemanding valuations, underpinned by corporate profits recovery and growth helped by historically low interest rates, light corporate taxation and unprecedented policy stimulus.  In addition, the successful free-trade resolution to Brexit ensures sterling’s stability and enables international investors to no longer fear that what they might gain in a share price will be lost through the currency. 

Ultimately, equity markets rise (as do all financial asset markets) only because of capital flows and more willing buyers than sellers (liquidity drives financial assets) and the UK equity market is home both to domestic champions and global scale winners with distributable cash-flows that can be purchased for cheaper risk-adjusted prices than those that prevail in other financial markets and asset classes.  

Inevitably, there is a long list of matters to remain vigilant about (starting with pesky Covid variants, changes to monetary and fiscal policy initiatives, the direction of inflation, crypto-currency bubbles, the sustainability of S&P 500 Index returns and geo-political relations) but we focus almost exclusively on the value of individual companies and here there is much to write home about.  In the last six months we have added 10 new holdings to the Fund, which seems a lot, but performance vindicates the transactions so far, and we are active managers following strict disciplines - which can be summarised as trying to buy only scalable businesses, de-risked by free-gifts within, by robust liquidity positions and by not overpaying - who just happen to be in a rich stock-picking environment.

In fact, the current period challenges us most with having to fit a quart into a pint pot.  We have met (i.e. Zoomed with) over 30 companies in the last number of weeks; there is undoubtedly a meetings distribution bias - because our stock-selection process tends to keep us focussed on structurally sound businesses and those moving in the right direction cyclically, i.e. covid-survivors and winners - but in outlook all the companies were positive and generally trading their recovery socks off, or just their ordinary (online) socks off.  

We are certainly not complacent about the future or performance. Indeed, we are rather frustrated as the 10 new positions could have been 15 or more, or a different mix of 10, which could have generated even better returns if we had been more insightful.  However, we are not displeased by the shape and structure of the portfolio currently; it has an agreeable balance between domestic champions and global scale winners with a clear bias to market leaders (and FTSE 100 constituents) for we expect the strong to simply get stronger as competitive advantages reinforce themselves.  Moreover, on reasonable holding timeframes we think the Fund holds more than a handful of potential double-baggers and one holding with the potentiality of a ten-bagger (which we exclude from our upside scoping).  Nevertheless, our scoping analysis leaves us quietly confident that the Fund should thrive and prosper, whether or not we are right about wider market conditions.

Source: Mirabaud Asset Management. 2021 data to 30 April 2021. 2017 data from 1 October to 31 December. Benchmark is FTSE All Share.

¹Mirabaud Asset Management, at 30 April 2021

²Mirabaud Asset Management, I Cap GBP. Index is FTSE-All Share. From 23 March 2020 to 10 May 2021.

³Mirabaud Asset Management based on the FTSE All Share

⁴Mirabaud Asset Management, in GBP

⁵Mirabaud Asset Management, in GBP

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