Hermes CEO Warns On Trio Of Market Shocks For 2018

Nine years into a post-financial crisis bull market, the CEO said by "all traditional measures" a correction was due - the question being over its severity.

Writing in the Looking into 2018 with Hermes report, published last week, Nusseibeh said any dip might be a "mere correction" of between 5% and 17% or it might be more extreme.

He said a "black bear" correction - the less aggressive of the species - would see a fall of around 25%, as was the case in 1957, 1962 and 1978.

Conversely, a "brown bear" scenario - considered the more aggressive - might be as extreme as c45%, as was the case in 1973, 2001 and 2008.

However, as QE keeps bond yields "absurdly low", high unemployment with no wage inflation remains and technology continues to advance, corporate earnings should be resilient, he said.

How to approach the 'long list of uncertainties' in US equities

Nusseibeh said: "That backdrop has led to a system anchored only in investor sentiment and perception, which is today struggling to make sense of the relationship of valuation of assets in relation to each other when the risk-free rate of return is only marginally above zero against a background of negligible inflation."

He said the consensus suggests while markets appear fully valued, they do not appear stretched, and considering the interest rate environment, this state is able to sustain itself "for some considerable time".

He added tensions were not systemic, but rather specific, "evidenced by the severe punishment of any stock whose earnings disappoint".

Yet the CEO said three shocks could disarm this "steady" state in 2018 - one was political, one was inflation-related and the other was the rise of bitcoin and digital currencies.

Despite a "sanguine" market response to the election of US President Donald Trump, Brexit and the rise of the far right, Nusseibeh said markets could suffer should Trump fail to deliver tax reforms.

Fidelity's Morse 'nervous' on European valuations

He added events in Catalonia or external shocks from the likes of North Korea also pose a threat.

Meanwhile, the CEO said hidden inflation was another concern: "We already see some evidence of hidden inflation in prime property in international cities for example, or even arguably the price of equities, which may hint at a hidden reserve of inflation that will eventually manifest itself in the wider economy."

Finally, he warned about the rise of digital currencies and the threat of protectionism.

He said: "The whole system of a post-Bretton Woods free-floating fiat currency system might slowly begin to be questioned."

But as none of these scenarios could be accurately predicted, he said "the best a long-term investor can do" is as Warren Buffett does.

On the veteran investor's favoured valuation metric of bond yield to equity P/E, Nusseibeh said: "[We] assume the valuation metric we are using continues to work... until it does not, and when it breaks down look at it - in [Buffett's] words - as a ‘sale' of assets we want to accumulate over the long term.

"In other words, steady as she goes but with an increasing awareness that all parties must come to an end sometime."