What is preventing another market downturn?

The red flags are there yet global stocks are holding strong

For a contrarian investor like Warren Buffett of Berkshire Hathaway, the current market cycle can be frustrating. Reuters

Being a contrarian investor is very frustrating at the moment; it always is when you are at the top or bottom of markets but can’t quite see a catalyst to reverse this position.

For those who have not met investors like these before, contrarians are people who try to buy assets at the bottom of a cycle and sell out before the top (or hold long-term). It sounds simple enough, obvious even.

Warren Buffett is the most famous contrarian investor whose investment credo really comes down to buying high-quality assets when they are temporarily out of favour for less than what he reads as their "intrinsic" or future value.

His approach is to run his existing businesses to produce a "cash pile" that he subsequently invests when markets are temporarily depressed. The last time this happened seriously was in 2009. His cash pile is currently about $112 billion.

Mr Buffett has been hunting for what he calls an "elephant" sized acquisition for several years. But he considers all candidates currently too expensive and is waiting patiently in the bush. Even at 88 he refuses to become an old man in a hurry.

True he did buy a lot of Apple shares last year and became the largest shareholder in America’s biggest company by market capitalisation. He can’t hold too much cash, or his returns would suffer, and it is the same for mere mortals, too.

That said Mr Buffett was the biggest loser in the stock market fall last autumn, with those recent Apple purchases a particular ball-and-chain pulling him down.

However, the elephant hunter has not lost his nerve and the volatility of the past six months - down 20 per cent and then up 20 per cent - is a classic indicator of a bigger US stock market swoon to come.

The yield curve inversion of the end of March was also a major signal, albeit it flickering off again in early April. That almost always indicates a recession is coming within six to nine months or a little longer.

Moreover the Dow Transportation Index is deep underwater and that indicates a "noticeable slowdown" in US business, as Mr Buffett himself pointed out last week.

Then if you turn to his favourite total market capitalisation-to-GDP ratio as a warning of overvaluation, it is flashing the same red alert as last October before the market suddenly crashed.

What then is preventing another market downturn?

The comments from ordinary American shareholders centre most on two factors: the Federal Reserve’s stalling of its monetary tightening policy at its last board meeting; and a likely boost to trade from a deal with the Chinese, at a shifting point in the near future.

It is a pretty flimsy construct. For one thing the Federal Reserve is highly unlikely to actually reverse its monetary tightening and cut interest rates until after a stock market event; for another, optimism about a reasonable Chinese trade deal is already written into current share prices.

All it takes really is for somebody to yell "fire" and the stampede for the exit could be one of the biggest in stock market history. What will be the catalyst?

In 2009 it was the bankruptcy of Lehman Brothers that spread fear and panic around the globe, crashed markets and gave Mr Buffett the chance of a lifetime to buy a stake in Goldman Sachs when its share price was on the floor.

Could it be Chinese or EU trade talks will turn sour and draconian tarriffs frighten market players? Or Brexit chaos return to worry markets. As these are unexpected or "black swan" events we can’t know in advance.

What we do know as contrarian investors is that it pays hugely to have cash ready to buy when prices are low. You have to be "greedy when other are fearful" and vice versa, as the "Sage of Omaha", as Mr Buffett is often referred to, says.

It is confusing to some investors that the same Mr Buffett also recommends tracker funds for the average investor, with regular contributions. But if you read the small print under this advice he goes on to explain this is only for those who can’t get contrarian investing right and, let’s be honest, it is not for everybody.

However, for those interested in personal finance and making an effort to get it right this is still by far the best-proven approach to growing your capital.

Contrarian assets cheap enough to buy at the moment would include: UAE housing, precious metals; US/Gulf bonds; non-dollar major currencies; Russian, UAE and Chinese equities (although that is not to say these assets can’t drop in price a little more in a financial crisis).

Where you need to be patient for a market bottom is a much longer list, including: US, European and Japanese equities; housing in all major global cities; commercial real estate; Indian and some other smaller equity markets; and industrial commodities, including oil.

Peter Cooper has been writing about finance in the Gulf for two decades