Like many investors, we worry about current equity market valuations looking historically high. Surely markets cannot continue to defy gravity? Although we believe that they are ultimately anchored to fundamentals, it pays to remember that we live in wealthy times. This chart shows the wealth of the United Kingdom, expressed as a multiple of the country’s national income. Wealth in the UK, and elsewhere, has grown substantially since the end of the second world war, and the financial crisis of 2008 did little to slow this down.
Following the financial crisis, it is not only the stock market that has risen, but so too has a populist political movement. Arguably the rise of Trump and the Brexit vote are the product of discontent over how wealth is shared within society. Cuts in public spending and low wage growth, coupled with rising asset prices, have clearly served to increase the divide between the haves and have-nots. It is not our place to take a view on the correct divide of wealth within a society, but we recognise that the debate forms one of the major components of the economic climate that we operate within.
Has this growth in wealth, coupled with low interest rates, created increased demand for owning stocks? Does this mean that markets are not heading for an imminent fall? Or has the bull-market seen valuations become too high? Are investors not fully recognising the realities of the current political climate?
Our approach to investing is to not rely on any one narrative being correct. We attempt to understand the intrinsic value of an investment in a range of different scenarios in the belief that this will help us be robust to an uncertain future. We want to be part owners of companies that are not highly leveraged, purchased at prices that do not require undue optimism about the future. Furthermore, our preference is to currently hold some “dry powder” outside of the stock market. This forms the major part of our “proceed with caution” approach to the place in which we find ourselves as investors.