Five ways to test whether spring will wake the FTSE 100 from its winter slumber

We are already two full months into 2017 and for all of the noise generated by the FTSE 100’s record-breaking run that began this year, the UK’s headline index is up by just a little more than 1% amid remarkably placid trading.

Such a sleepy start to the year has many market-watchers on edge although history suggests it is normally a good rather than bad sign.

As of the end of February, and the first 41 trading days of 2017, the FTSE 100 had moved by more than 1% in a trading day from open to close just once.

That compares to a post-1995 average of one such gain or retreat every five trading days, so normally we would have seen seven or eight such movements by now.

The only other year to start so quietly since 1995 was 2005. It also saw just one move of 1% or more and the FTSE 100 ended the year with a 16.7% capital gain.

Other years to feature five or fewer daily gains or losses of 1% were 1995, 1996, 2004, 2006 and 2014. In only one such instance – 2014 – has the FTSE 100 ended the year with a loss.

FTSE 100 has tended to do well after quiet starts to a year

Source: Thomson Reuters Datastream.

There is no guarantee that history will repeat itself – if investing was that easy then the best and richest stock market punters would be librarians – but the figures could be seen as providing support for the old saying that ‘markets climb a wall of worry (but slide down a slope of hope).’

Advisers and clients seeking exposure to UK equities are spoiled for choice. The tables below look at those collectives which seek to provide optimal risk-adjusted returns from large caps, but it is also possible to target mid-caps, small-caps and equity income, to name just four available variations.

Best performing UK large-cap equity OEICs over the last five years

Source: Morningstar, for UK Large-Cap Blend Equity category.
(Where more than one class of fund features only the best performer is listed.)

Best performing UK equity investment companies over the last five years

Source: Morningstar, the Association of Investment Companies, for the UK All Companies category

Best performing UK large-cap blend equity ETFs over the past five years

Source: Morningstar, for UK Large-Cap Blend Equity category.
(Where more than one class of fund features only the best performer is listed.)

Wall of worry and slope of hope

Markets’ ability to climb that proverbial wall of worry is the stuff of market lore and they certainly have plenty of issues to ponder.

These include whether President Trump can deliver on his planned tax-cutting, infrastructure-spending and deregulating plan (and whether it will generate better economic growth if he can), Europe’s forthcoming elections and their implications for the euro and the UK’s ongoing debate over Article 50 and what it will mean for our economy.

And they are just for starters.

The second half of that saying, the bit about sliding down the slope of hope, is much less well-known but its serves as a useful reminder to advisers and clients to guard against complacency.

It is when expectations – and hopes – are at their highest that disappointment tends to follow and those setbacks initially lead to higher volatility and finally a broad market retreat.

This is shown by analysis of daily movements in the FTSE 100 of 1% or more from open to close.

The best years for the market come when the number of such daily rises or falls is very limited – 1995-1997, 2004-2006 and 2012-2013 for example.

As volatility picked up, the FTSE 100 did make further gains (and often substantial ones), although these are much more hard-won as markets begin to take several steps back before they rise, as higher expectations (in the form of higher valuations) left them prey to potential disappointment.

The 1998-1999 period, along with 2007, were both instances when spikes in volatility acted as a warning that all was not necessarily well, even if the headline index advanced.

FTSE 100 has done best when volatility was low and worst when volatility was at its most extreme

Source: Thomson Reuters Datastream

The final stage after calm and then gathering concern has tended to be panic as hopes for further earnings and dividend growth were conclusively dashed.

Volatility rocketed as bears mauled bulls and drove the FTSE 100 lower during 2000 to 2003 and then 2008 to 2009.

Yet it is when volatility peaked and fear was at its height that advisers and clients would have reaped the greatest rewards by stepping in and starting to buy. Psychologically this is so hard to do but as legendary investor Sir John Templeton remarked: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”

If any advisers and clients do wish to try and time their involvement in the market – and many will sensibly eschew the dangers and expenses involved – this can at least act as some form of guide as to when to start researching funds to buy (or sell).

Five signals

The good news is that the snoozy start to 2017 does not smack of euphoria. It is therefore possible that we have yet to see the ‘beginning of the end’ for the bull market that began in 2009, in the absence of the sort of volatility which traditionally acts as a red flag.

That said, advisers and clients should not be complacent and must look instead to build a well-balanced, long-term portfolio which prepares them for, and protects their money from, a range of potential market and economic scenarios and not just the one they think will come to pass.

Given that markets seem to think President Trump will launch – and be able to pass – a series of wide-ranging tax and regulatory reforms, the EU will again fudge its way through a Greek debt crisis and the French and Dutch elections will see anti-EU parties fail to prevail, it might at least be worth thinking about the alternative outcomes.

The markets will be reacting to these, and other, issues, across a range of asset classes and geographies, and time-pressed advisers and clients might like to keep an eye on these five tests of the market temperature.

All have sparked into life in the past fortnight or so in a manner which suggests someone, somewhere is a little less bullish than before. None suggest markets are about to turn turtle. But a continuation of some of the trend reversals seen might herald a revival of market volatility after its winter hibernation.

The first trend to watch is the performance of Government bonds. UK 10-year Government bond yields have rattled lower and their US equivalents have also gently pulled back. This may imply an ebbing of faith in the Trump-reflation trade, as anyone embracing it would remain wary of fixed-income and the potential for inflation to erode the value of coupons (and lowly running yields) in real terms:

UK and US Government bond yields have come down

Source: Thomson Reuters Datastream

This trend has in turn brought utilities back into focus. These stodgy so-called bond proxies (so called as they tend to be purchased for their yield rather than capital appreciation) have begun to stage a tentative share price rally after a period in the doldrums. The chart below shows the S&P 500 global utilities index but the same pattern can be discerned at local level in the UK or USA, for example.

Utility share prices have stopped falling ...

Source: Thomson Reuters Datastream

The third trend is the banks – they have stopped rising as the utilities have stopped falling. As noted in recent columns, the banks are a key indicator of not only risk appetite but also global economic health. If the banks stop performing then something nasty could be lurking, so this is definitely a sector which merits attention, whether advisers and clients have exposure or not.

... and banks’ share prices have stopped rising

Source: Thomson Reuters Datastream

A fourth proven indicator of rising risk-aversion is the yen, which tends to rise when markets are unsettled and fall when all is calm.

At first glance this seems bonkers. Japan’s economy is drowning in debt and has awful demographics, factors which leave it still flirting with deflation after nearly 30 years of trying to bear it.

Yet the yen is seen as a haven for three reasons. First, Japan’s Government may be skint but corporate and consumer savings rates are high. As a result, Japan’s sovereign debts are nearly all held domestically and the economy is not subject to the whims of international capital flows. Second, Japan tends to run a current account surplus so it is a net creditor to the world. At times of stress Japanese investors will sell overseas assets and repatriate currency, creating demand for yen. And third there is the carry trade. Japan’s 25-year experiment with zero interest rates means the yen is widely used as a funding currency, as speculators borrow in yen at minimal cost and park the money where interest rates are higher elsewhere. At times of market dislocation those trades tend to be closed in a hurry, forcing sales of other currencies against the yen so those borrowings can be repaid.

The yen has stopped falling against the dollar

Source: Thomson Reuters Datastream

The final risk-aversion indicator to watch is gold. The precious metal has had a good run and has held on to the $1,250-an-ounce mark thus far.

Gold has firmed in 2017

Source: Thomson Reuters Datastream

Not all advisers and clients will warm to gold, not least as it generates no yield and has little or no industrial use. Gold has historically been used as a hedge against (hyper)inflation or deflation but it has also done well at times of stress in credit and debt markets, or when faith in official policy has ebbed.

It is therefore interesting – but by no means conclusive – that the metal has done well over the past few weeks. This trend, along with the other four, should be worth monitoring. A further revival could spell trouble ahead, or at least more volatility. If they go quiet then equities could well be set for further gains.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.