Since 1987, when the first major ‘market crash’ since World War II occurred, the MSCI World has seen many all-time highs. But only on three occasions, it has avoided a market correction of at least 10% within the next 12 months.
Two of the three previous episodes equities managed to power on for a sustained period after hitting a record high, date back to the economic boom of the 1990s.
After the MSCI World hit a record in the autumn of 1993, it wasn’t until the Asia crisis in 1998 when equities reversed course. But by the end of the year, the MSCI World was back at its previous high, and the index powered on until the next crash in 2000.
The third time the MSCI World rallied on for more than a year after setting a record was from autumn 2012 to summer 2015, a period of almost three years.
What are the odds this performance will be repeated after 2015’s record was broken two months ago?
Since the United States account for about 60% of the weighting of the MSCI World index, and for over half of the MSCI All Country World Index, we’ll have to concentrate primarily on the US for clues. Fact is that at two of the three multi-year bull markets that followed a MSCI world record-high, US equity valuations were significantly lower than they are now: in autumn 1993, the S&P 500’s Shiller P/E was around 21, and in 2013 it was at 24, compared to a score of 27 in November 2016 (the Shiller P/E stands at 29.15 now, the highest level since 2001).
That leaves 1998, when the Shiller P/E stood at 38 when the MSCI World (and the S&P 500) set an all-time record. However, this period could be considered an anomaly because the valuations of the S&P 500, like many other developed market indices at the time, were distorted by the dotcom boom.
Moreover, and this is a big contrast with 1993, 1998 and 2013, the Fed has now embarked on a rate hiking cycle. Traditionally, rate hikes are bad news for equity prices. If the Fed this time holds true on its promise to ’normalise’ rates, a market correction may arrive sooner than some expect.
And if Donald Trump fails to deliver on his promise to cut taxes and instead follows through on his protectionist campaign pledges, US equities will come under intense pressure considering investors have priced in the exact opposite.