Stock market cycles over the years
This time it’s different they say (Stock market commentators say this every time there is a market crash or severe correction). So, this time, is it different, or is it the same old stock market activity with a slightly diverse set of causes?
It has been an odd few years in the stock market since late 2019, in some ways reminiscent of the technology induced crash of 1999/2000. Back then we saw, in the mid 90’s, the beginning of the rise of the Tech giants and the internet (remember AOL?) was starting to become much more capable of changing our lives both at work and at home. But fast forward 22 years and we find ourselves in a similar situation today.
It is important to recognise where we are in any economic, business and stock market cycle, because that should dictate our behaviour in positioning our investments. There are some companies to stay away from at the moment, maybe even forever, and there are some that will do well in the next phase of the market cycle.
When people suggest you should not worry about short term market movements, I’m reminded of Vodafone for example. A tech giant in the late 90’s, its share price ran from 40p to £4.97 in just 2 years – then fell in the 99/2000 tech crash and today trades at £1.31. So, if it was added to your portfolio in late 98 or 99, 22 years later you would still be waiting for a return to break even, let alone a profit.
So, whether you are new to investing or have an existing portfolio, you and your adviser should always be looking at what is happening and how that affects your future growth prospects.
A look back at History
To understand where we may be today in the economic and stock market cycles, and what to do with our investments, we need to take a quick look back through history.
The rise of technology in the late 90s brought an enormous increase in the number of tech start-ups – internet and technology companies that had no earnings, no profit but lots of apparent potential. The shares in these Companies skyrocketed as the investing world whipped itself in to a frenzy of excitement about just how much these companies were going to be worth in the future. (Sound familiar?).
Eventually, reality struck, and everyone realised that a company that does not yet make or supply anything or does not have any income or make a profit is not a great investment. In other words, people realised that “potential profits in the future” are not as good as real profits now.
As always, many professional market participants had started selling long before the majority caught up and while a few made a fortune, many people lost one.
Once the Technology crash of 1999/2000 had worn itself out, markets flailed around in a narrow range looking for that reason to start a new bull run. As we have discussed before, stock markets simply work on supply and demand. The more a company has a product or products that are in demand, the greater its profits and the better the actual profit and future profit potential, the more likely that company’s share price will go up.
Stock markets also react badly to fear and uncertainty. The market position in 2001 was made worse by the tragic events of 9/11 and the overall outlook worsened with the start of the war in Afghanistan. Then, in March 2003, market participants concluded that with the start of the 2nd Iraq war, as bad as war and conflict is in so many ways, the uncertainty was gone. War always brings an increase in defence spending and globally companies reacted well to this, sparking an economic boom, fuelled further by cheap credit and the mortgage market.
Of course, this then led to the global financial crisis in 2008 which ended the prevailing economic cycle and caused a total reset in global economies. With a few bumps along the way, we then enjoyed almost 12 years of global economic prosperity.
Enter the new decade
It’s no surprise then that we arrived at the beginning of 2020 with a cooling economy and some stock market uncertainty. You could argue that we were a little overdue for a pullback in markets, but in March 2020 the Covid pandemic accelerated that process to produce a significant fall in global stock markets.
There was much debate about the shape of the recovery from that fall and it turned out to be a sharp V. By the end of April markets started to recover, led by Technology shares, because in the brave new world we were all going to work, play and exercise from home forever.
The rise in the value of Technology shares was strong and significant, companies like Peloton, Netflix, Facebook etc all looked to be the future. In fact, share prices soon started to rise out of proportion with the value of the company and its current earnings and profit. People started to imagine the potential in these companies, I mean, surely when Covid was over we would all keep buying our Peloton bikes and subscribe to even more Netflix and Disney accounts, why would anyone go to a gym again and even if we did return to work surely, we would still have all that time for subscription-based TV.
With all the government stimulus money and mortgage repayment holidays, many people found themselves with disposable income like they had never seen before. So, they decided to spend that on house renovations and” stuff.” What is more, why go to a shop anymore, the new way to live would obviously all be based around staying at home. So, in 2020, 44% of items bought in the UK came through Amazon.
With the sudden new rise in Technology and the changed world, people began to believe that it was always going to be this way now and we saw a rise in new Technology Companies coming to the market, Companies that were not yet making a profit and did not have strong or even any earnings – but they had amazing potential (Sound familiar?).
Cathy Wood’s famed ARK Innovation fund rocketed upwards, investing in Companies that are going to be worth a lot – in the future, but don’t earn a profit at the moment!
Enter reality
In 2021, stimulus and lockdowns continued but we slowly returned to work and by the end of the year, many investment professionals started to believe we had seen the end of the “Covid” economy. Stimulus would stop soon or had already stopped, people were returning to work, many were back at the gym and spending was slowing down.
By this point, an old enemy of economic prosperity – Inflation – started to rear its head. This was only to be expected really, given the massive spending in the pandemic coupled with supply chain issues brought about by global pandemic shutdowns causing a reduction in supply while demand increased.
The economic position worsened this year as global central banks started to raise interest rates to try to control inflation, which is never good for the public or a company that is looking to borrow and grow.
Common sense dictates that the levels of spending seen in 2020 and 2021 could not continue without global government stimulus, so company profits in 2022 and 2023 could never be as good as or better than the previous 2 years. The position was made worse by the uncertainty introduced with the start of the war in Ukraine.
Quite why then the world was surprised when companies started to release earnings below expectations from the beginning of 2022 onwards, I have no idea.
As earnings from mainstream companies constantly disappoint, attention turned to those companies that are yet to earn anything or turn a profit. Again, unsurprisingly, people realised that investing in a company that has “potential” but no profit is not always a great idea.
With the grim realisation that these companies were not worth their share price, markets fell and some of the Covid darlings almost collapsed – Peloton down over 80%, Facebook down over 50%, Tesla down almost 50% from its high, Netflix down over 75%. The ARK innovation fund is down in value by over 57% in the last year, investing in companies like Zoom, Telodoc, Roku and Beam Therapeutics.
So, we have seen another fall in global stock markets, led by Technology shares. But overall, this time we also have a war, inflation, rising interest rates and an economic slowdown, much of which may have been caused by the pandemic spending burst.
In conclusion
It is no real surprise we are seeing a pullback in stock markets and global mini or mid cycle recession; I think it should have happened in early 2020 but the covid pandemic seems to have delayed it and made it a bit worse than it could have been.
It has been a difficult couple of years, and we have been mostly in cash since mid 2021 so we missed some of the rise last year, but we also missed the brutal falls in many markets this year so far.
Putting my neck on the line, I think the second half of this year will be marginally better as we move out of the mid cycle pullback. There is a lot to be positive about – demand remains high, unemployment remains low and globally, once we are through this difficult inflationary period, economic development is likely to fuel a further period of prosperity from 2024 onwards for another decade or so.
So, the current environment provides an excellent opportunity to position your portfolio for robust growth over the next 5 to 10 years. The new readjusted norm is to invest in companies that actually have earnings and make a profit.
What we are seeing now is a Tech led market correction, made worse by the pandemic, inflation, and a war.
So, looking at the facts, history tells us that this time, it is different in some ways, but actually the same as always.
We are always here for advice, get in touch info@middletonprivatecapital.co.uk.