Don't pay attention to the markets, but rather the doomsayers

Experts in the market assert that investors will inevitably face catastrophe

However, the market is not in agreement. When in doubt, follow the market.

The topic of the Merryn Talks Money Bloomberg podcast on April 17, when markets reached record highs, was "Are markets just plain wrong to keep looking through the Iran war". As previously stated, the answer is most likely not. John Stepek stated on the show, "If you think the market is wrong, it's probably not the market, it's you." Although geopolitics is renowned for having little impact on markets, whenever a disruptive geopolitical event occurs, a never-ending stream of experts declare that investors will inevitably suffer a catastrophe.

The experts have rarely been as mistaken as they were this time. Both the S&P 500 and the FTSE 100 saw a 9% decline from peak to bottom in late March before rising significantly over the course of the following three weeks. The analysts projected that the price of oil would increase to £150 or £200 per barrel, which would cause inflation to spike, raise interest rates, and trigger a recession. Stock markets would plummet and corporate profits would be severely impacted. Gold was the only thing that was safe.

Rather, the price of oil has struggled to surpass £100, gold has dropped by roughly 12% since the beginning of March, bond yields (apart from in the UK) have decreased, inflation has only slightly increased, and there is no indication of a recession, though interest rates will likely rise, particularly in the UK. Anyone who took action to "reduce risk" after listening to the pundits will have lost money. Things worsen. The much-maligned "magnificent seven" mega-caps have led the US market to soar ahead rather than falter as confidently anticipated. The potential victims of AI in the software and data-provider industries are the ones who have suffered, not the AI "bubble" itself. Forecasts for earnings have kept rising. Historical parallels that, upon closer examination, proved to be untrue greatly influenced the predictions of impending catastrophe.

BFIA's current problems. ...

Doomsters find little comfort in the market.

What lessons should be learned for the future? There will undoubtedly be more disruptive geopolitical crises, and when they do, the "end of the world is nigh" crowd will be out in full force, controlling the media's attention with their dire predictions of impending catastrophe and justifications for why markets are being completely complacent. Pessimists are already scanning the horizon for the next market-upsetting crisis. Doomsters are unlikely to find comfort in that conflict now that the balance of power in Ukraine has shifted against Russia. If Ukraine wants to destroy the Kremlin, its missiles are capable of taking out oil facilities along the Baltic coast. Prophets of doom have long warned of a Chinese invasion of Taiwan, but it is still a very dangerous endeavor for a nation whose last military adventurethe invasion of Vietnam in support of the Khmer Rouge in Cambodiawas more than 50 years ago and proved disastrous. Additionally, a seaborne invasion is now even riskier thanks to modern drone technology.

There will undoubtedly be new reasons to be concerned about geopolitical events, but the important question is not what these events mean for markets, but rather what the market's response indicates about their significance. The market's response is correct nine times out of ten, including this time, and the doomsters are mistaken. Nevertheless, the story of the boy who cried "wolf" tells us that there may come a time when those who cry wolf are finally correct. Instead of a brief decline that was quickly reversed, stocks have not experienced a prolonged bear market in almost 20 years. The US market is costly and reliant on a potentially unsustainable rate of earnings growth. Due to slow or nonexistent economic growth, the UK and European markets are no longer cheap; rather, they are reasonably valued with few opportunities for earnings growth. Asian markets have come a long way in a short amount of time.

Nathan Rothschild said, "Buy on the sound of cannons, sell on the sound of trumpets," about 200 years ago. Although it appears that markets will continue to produce positive returns for the remainder of the year, taking some profits is currently beginning to seem like a better strategy than charging in. "Earnings growth and economic expansion drive markets, not geopolitical shocks," as US strategist Ed Yardeni reminds us. With the S&P 500 projecting earnings per share for the upcoming 12 months at £344.30 and anticipated to reach £380 by year's end, earnings expectations are still rising. As a result, the index has a forward multiple of 20.8 and will drop to 18.8 by year's end. The forward multiple for the "magnificent seven" is nearly 27, while it is approximately 16 for the mid- and small caps.

That may sound difficult, but Yardeni points out that the information-technology industry has benefited from a 33 percent increase in projected revenue and a 55 percent increase in projected earnings over the past 12 months, with the sector up 8 percent so far this year. Up from 15% ten years ago, the semiconductors subsector now makes up 42% of the industry and accounts for 47% of projected profits. Its prospective multiple is actually at a slight discount to the S&P 500 due to its skyrocketing expected earnings. Fears that AI will eat into its markets have caused the application-software subsector's multiple to more than halve since 2021, to 23.4, the lowest reading since 2014. Even though Nvidia is valued at £5 trillion, this indicates that the enthusiasm of the previous year has given way to a more sober evaluation that identifies both winners and losers.

Three of the magnificent sevenAmazon, Meta, and Teslaare not included in the information-technology sector, which makes up 28% of the S&P 500. Technology makes up 45% of the index when all AI-related shares are included, and it has doubled in just three years. According to Liam Halligan of The Telegraph, this is unsustainable, much like the energy share of over 25% in 1980 (now only 3%) or the railways' share of over 60% in 1900. That is probably true, but it doesn't show that the US market is overpriced; rather, it shows that the sector composition of the market will continue to shift over time. Pundits from the UK and Europe, on the other hand, can only watch with envy as their markets are much more affordable. However, their reliance on imported energy and their limited exposure to technology result in slower revenue and earnings growth as well as a large valuation discount.

Halligan is on more solid ground when he notes that the US market's cyclically adjusted price/earnings (Cape) ratio is at an all-time high. In the long run, this has proven to be an unreliable indicator due to shifting corporation tax rates, accounting regulations, and its retroactive nature. In an attempt to balance the fluctuations of the economic and earnings cycle, it computes the ten-year rolling average of corporate earnings. The current level indicates that there hasn't been an economic recession for well over ten years, only brief dips. During recessions, earnings fall precipitously, which lowers the Cape.

Be cautious and continue to invest.

Although there isn't a visible recession, corporate profits will decline when one does. Furthermore, overly optimistic accounting, shaky finances, and weak business models are always revealed in bear markets. A moderately valued market that acts as a buffer against disappointing earnings is the best defense against this. Investors are treading carefully because a ten-year US Treasury yield of about 4.5 percent and a multiple of earnings above 20 do not offer that. Global diversification might not be beneficial because other markets might offer better value but slower earnings growth. Although they are doing well, emerging markets rely largely on the Far Eastern technology super-stocks. It is difficult to envision other markets continuing if the US market falters.

Investors should exercise caution, but there's no need to panic. Markets can relax about 2027 if they remain flat for the remainder of the year and restore value. Even if peace returns to the Middle East and Ukraine, oil prices decline, and the political landscape improves, 2027 may be troubled if they keep rising.