Five turbulent and highly unpredictable years on stock markets have led investors on a dizzying ride. No-one can be sure where the next five years will take equities, but some lessons can be learned from the recent past.
It is 2025, and stock markets are… well, if we knew for certain where they’d be in five years’ time, we’d all be rich and looking forward to a comfortable retirement in an exclusive location during the second half of this decade. Nor is it a particularly good idea to assume the future will be much like the past, especially given the shape of the market chart during the past five years.
Had you bought the index on 26 March 2015, when it stood at 1,744.90, you would have been less than pleased by February 8, 2016, when it was down at 1,498.54. Hang on until October 2017, however, and you would have cheered as it broke decisively through 2,000.
Huge importance of policy changes
This onward progress continued to January 24, 2018, when the index reached 2,232.40 before dropping to 1,862.38 on December 27, 2018. An upswing took it convincingly through 2,250 in the autumn of 2019, up to a peak of 2,421.26 as recently as February 11, 2020.
As the coronavirus epidemic took hold, the MSCI World Index went into a spin, down to 1,694.45 on March 16. The $2trn US fiscal stimulus agreed this week by US legislators seems to have lifted it somewhat, and by March 25 it traded at 1,785.99.
The first is that equities are hugely influenced by major changes to fiscal and monetary policy. The election of Donald Trump as US President in November 2016 was followed by a lax stance on spending and demands that the US central bank, the Federal Reserve, loosen monetary policy.
This had the predictable result of raising the value of assets, such as shares, not only by encouraging investors out of low-yielding cash and into potentially more rewarding investments but by, through tax cuts, giving consumers more to spend, thus increasing corporate profits and making company shares more attractive.
Watch for real, not passing, events
It seems unlikely that Hillary Clinton, had she won the 2016 election, would have embarked on such extensive stimulus measures, given her husband Bill had actually eliminated the deficit during his presidency.
This takes us to a second lesson from the past five years, which is that it is real events, rather than passing news items, that have the real impact. Thus Trump’s election mattered, while the attempt to impeach him did not. The coronavirus is important for stock markets, while even wars in Syria and Yemen, while tragic for those involved, were not.
Even the UK political deadlock last year over Brexit, which at one point threatened a constitutional crisis, did not seriously disturb stock markets. By contrast, the US-China trade dispute seemed likely more than once to send markets downwards.
From this follows a third point, which is that markets are understandably sensitive to the prospects for economic growth worldwide. They are considered to be “leading indicators”, in other words pointing to future prospects unlike, for example, labour-market data, known as “lagging indicators”, telling us where we have been rather than are going.
Outsiders are sometimes enraged to see share prices booming at a time when unemployment is still increasing. Defenders of equity investment would point out that rising prices are a sign of confidence that recessionary conditions are passing and that economic activity and job creation will shortly resume.
US dominance of index
But there are no guarantees that the market is right. Remember the old joke about Wall Street having forecast nine of the last five recessions.
Finally, two points. One is that pricing is key. If a market looks expensive and overbought, it is likely a correction will set in at some point. Furthermore, it may well be at just the point when you are tempted to buy into such a market that prices start to decline, as existing holders seek to take profits and find it difficult to find anyone to buy at current levels.
The second is that markets, although linked by a largely seamless digital flow of capital, remain distinct. The MSCI World Index is a very useful gauge of market activity in the 23 countries covered, including about 85 per cent of the stocks available to purchase in each country.
But it is dominated by the US market (63.08 per cent of the index), and to a lesser extent those of Japan (8.21 per cent), the UK (5.47 per cent) and France (3.8 per cent). Someone specialising in the stocks of the Netherlands (1.33 per cent of the index) or even Germany which, for all its economic might, makes up just 2.86 per cent may well be able to develop a focus on the markets concerned that will give them a more specific feel for where prices are likely to go during the next five years.
To build a more or less realistic stock market forecast for the next 5 years, smart traders and investors will keep their eye on any big changes to monetary and fiscal policy. They will concentrate on meaningful political events, rather than passing “furious rows” and the like. They will constantly look at how economic prospects are affecting the market.
Always on the look-out for “froth” in terms of pricing, they will consider specialising in a market in which their expertise and knowledge give them a real competitive advantage.
Let’s see where we are in five years.