Double shift marks a turning point

Up to a point, these moves can be seen as a reaction to the hangover that followed the end of the stockmarket bubble. From 2000-2005, the sectors that did particularly well in the earlier period, including growth stocks and large-caps, generally performed relatively poorly. Now they appear to be coming back into fashion. But the shift back should not be seen as just another inevitable oscillation of the investment pendulum.

There were particular reasons why growth stocks and large-caps did so well in the late 1990s. The growth sector was closely associated with the boom in technology stocks, and large-caps were generally favoured because of their liquidity – it was easy for speculative investors to buy and sell them. Investor momentum in both areas led to them becoming overvalued.

More recently, investors have clearly preferred other areas. Mid-cap stocks have done particularly well, while investors have generally favoured value over growth. However, it would be a mistake to see the current double shift as a return to the heady days of the stockmarket boom. It is likely to be a long time before such consistently strong stockmarket returns are repeated.

Two features stand out in today’s financial markets. First, and most important, there is an enormous amount of liquidity in the global economy. For example, the capital flows from Asia to America alone are huge. In addition, much capital has flowed into bond markets and property investment in recent years. In many ways, this is a continuation of a trend from the 1990s. Surplus liquidity creates the basis for the emergence of bubbles in financial markets. When investors become nervous about one asset class, they shift in a herd towards others.

Second, interest rates have risen for the past two years, but only recently, particularly in America, have they turned positive. Rising interest rates are more significant for financial markets than ever. The huge boost from negative real interest rates played a key role in bolstering financial assets in recent years. The end of this trend means the removal of an important support for shares of all types in the period ahead.