Investors are at risk of falling into a "bull market trap", with the dual tailwinds of ever-decreasing interest rates and the so-called 'Fed put' unlikely to sustain stockmarkets indefinitely, according to Ruffer's Duncan MacInnes and Fiona Ker.
The pair of investment directors worried that valuation measurements across the board in the US market are "flashing red simultaneously". "The disconnect between what investors are pricing in and the sobering economic reality [of the Covid-19 recession] is quite stark," MacInnes told clients on Thursday (26 August).
"If you look at price-to-sales, price-to-book, cyclically-adjusted price-to-earnings, or the Buffett indicator [market capitalisation-to-GDP] [they all] suggest we are in the most expensive 10% of observations in the last 100 years.
"[That] does pose the question: are we in the best 10% of economic observations in the last 100 years?
"Each of these metrics has a decent case for being predictive of future returns to investors. They also all look at different things: some are measures of sales, some are measures of profitability, others focus on the balance sheet, but all of them flashing red simultaneously would suggest some caution.
"This is a key reason why we have our lowest weighting to the US equity market in 14 years in our portfolio."
Ker added that despite "pessimism on Main Street", encapsulated by a swathe of bankruptcies seen due to the pandemic, "the market shows some signs of frothiness".
Ker said: "The dotcom boom famously had its day traders, while the rally since 23 March has been cheer-led by [Barstool Sports blog founder] Dave Portnoy.
"Leading an army of Twitter followers investing their stimulus cheques, Dave livestreams his trading to his 1.7 million followers and uses phrases such as 'stocks only go up' and 'Warren Buffett is washed up, I am the captain now'.
"In our experience, these sorts of oddities tend to cross-over into the mainstream more often at market tops than they do at market bottoms."
Further, MacInnes noted, some of the trends that sustained the bull market throughout the 2010s are likely to dissipate in the near future. Interest rates plunging from 17% to zero over the past 40 years, for instance, allowed all risk assets to rise simultaneously.
However, MacInnes contended, "this trend has probably run its course". "It seems unlikely that [interest rates] will spend the next 40 years falling," he argued.
Ker noted the bulls had been emboldened by the fact that "central banks and governments are clearly determined to print and spend their way out of this and that is surely supportive to equity prices".
The recent popularity on social media of the 'money printer go brrrrr' meme and a recent Economist front page on 'free money', she contended, were "the same as 'don't fight the Fed', a concept that has been around in markets for decades".
Indeed, said MacInnes, investors have benefited from the so-called 'Fed put', which contends that central banks, led by the US Federal Reserve, would lower rates or call on quantitative easing every time financial markets or economic conditions worsened.
"So, with the downside capped, investors and companies have been able to take on more risk than they otherwise would, and why not when the Fed has your back?
"But this theme is becoming more complicated. Central bankers have admitted that they are running out of tools, and they have called on governments and fiscal policy to help them achieve their goals. This is a sign that the era of central bank omnipotence is coming to an end."