Rising like the pheasant

The Weekender offers my perspective on market developments and their potential broader implications, written fortnightly on Friday afternoons. If you'd like this delivered to your inbox on Saturday mornings via Northern Trust, please sign up here.

Market tops

The brilliant Jawad Mian believes US stocks could be range-bound for a decade, à la the 1930s, 70s, and 2000s. He argues in this Bloomberg interview that stocks are currently in a topping process. All the necessary conditions are met for a bear market, and we’ve had our first crack via the AI zeitgeist of DeepSeek. He thinks US exceptionalism has moved on to exuberance and new market leadership will emerge, noting that the sector which leads you into a new era seldom leads you out.

Of course, it’s far too early to tell. We may simply be consolidating before the next move higher. But what is clear, and as we’ve discussed, uncertainty around policy, tariffs and government layoffs may slow activity before the benefits of deregulation, tax cuts and productivity kick in. An ‘air pocket’ is possible in the interim. One that US stocks could fall into, causing Equity Risk Premia to surge. And if that happened, our discussion on buying index puts may seem timely (there’s a first for everything). So too could diversifying regionally.

But what if Mian’s right?– what if if markets are rangebound for a time. What should investors do then?

Don’t panic. With dividends

In Who’s Afraid of a Sideways Market? Rob Hagstrom looks at the Dow between October 1, 1975 and August 6, 1982. At the beginning of that period it was at 784 – exactly where it closed at the end. But despite the index going nowhere he discovered nearly 40% of Dow stocks doubled over that period. So, don’t panic. The market may do poorly, but some stocks can do very well. You just need to own those stocks.

So, what were the characteristics of those stocks? And might they work again? Well, many displayed Quality factors like high cash-generation and pricing power. They had value attributes (for it is earnings-growth, not price-to-earnings that drives returns during periods of multiple compression). And critically, they paid dividends, which is a factor that I believe is long overdue a comeback. Afterall, dividends have accounted for 40% of stock market returns since 1930 and over 50% during periods of inflation. And inflation remains sticky.

The last mile

The last mile for inflation was always going to be the trickiest part. Arnott and Shakernia (2022) in their study of inflation persistence in 14 developed economies from 1970 to 2022, found that: “reverting to 3% inflation… is easy from 4%, hard from 6% and very hard from 8% or more. Above 8%, reverting to 3% usually takes six to 20 years, with a median of over ten years.” So, inflation volatility could remain for some time. That’s good news for supply constrained real assets (gold) and quality cash-compounding equities, with high starting dividends.

The diversification deficit

I would go further and suggest we should isolate the compound dividend factor, package it in an index and promote it as an alternative diversifier. After all, as Oxford Economics suggest, current alternatives may not be good diversifiers. In fact, many portfolios suffer a diversification deficit. Take bitcoin, which is trading suspiciously like the Nasdaq. Or private equity, where the key is in the name (i.e. equity). The current return metric most LPs care for is DPI, “as you can’t eat IRR”. And cash returns last year were single digit.

In contrast, I can find good quality dividend compounders, with starting yields of 4-5% where the denominator is likely to fall (via buybacks) meaning those returns compound. Said differently, it won’t take long for cash returns to reach double digits, and that’s with little leverage and no price appreciation. This logic (and patience) allows Buffett to clip +55% dividend on his initial investment in Coca-Cola. I’ve also noticed Northern Trust’s own Quality Dividend Index is outperforming by 140bps (at time of writing). A coincidence or a sign? A signal that total return investing could be about to make a comeback?

The nature of comebacks

Last year we discussed the comeback potential (albeit likely painful at times), of markets like Europe, the UK and China. The nature of good comebacks is that they “emerge from obscurity, and the deeper the shadows from which they spring, the more drama surrounds the comeback — once it is recognised”.

Other than the German Dax – which has quietly outperformed the S&P since the October ’22 lows – the comeback from Europe, the UK and China has been quite dramatic. And in the case of China, my suspicion is that Xi wants this play to continue. More measures are being planned to promote equity participation, SoEs are incentivised to get stock prices up, entrepreneurs are being celebrated again, and more stimulus is expected for the property market which is showing tentative signs of bottoming.

Now, this is key. For if you fix housing you fix a lot of things, not least collateral, confidence, consumption and by extension commodities. As such, I would keep a very close eye on the SHProp Index. It’s possibly the most important chart in markets.

Just imagine the drama if it too staged a comeback…

Asymmetric beta

And if you are minded to close your underweight positions and take more active share in China, if you don’t use derivatives and are benchmark aware, then the idea of asymmetric beta as discussed by NTAM’s Michael Hunstad might appeal? In this discussion he argues that it’s possible to skew a portfolio towards higher quality stocks without increasing tracking error while giving you lower beta on the downside. And if you speak to him, quiz him on why he thinks ‘quality’, and increasingly ‘dividend’ are factors you might consider more in your risk and allocation models.

The most important question

One of my favourite books was The Art of Learning by Josh Waitzkin. It was the first time I’d encountered the concept of a ‘growth mindset’. His approach to learning successfully transitioned from chess to Brazilian Jiu Jitsu?to coaching high-performing athletes and fund managers. He was recently interviewed by Andrew Huberman. There is a 7 minute excerpt which I think is relevant to every investor. Huberman talks of being bombarded by noise in a never-ending game of stimulus – response. Noise which crowds out space for critical thinking. Waitzkin describes how to cultivate this space and introduces his Most Important Question (MIQ) Process: “a way to train ‘thinkers’ of discovering what matters most”.

Applying this process to markets is, I think, most important with regard to China in assessing whether property has bottomed. But how to determine similarly for the US? For that we may need to identify Trump’s MIQ. For markets, he seems to matter most.

Inequality

Earlier this week the WSJ reported that the top 10% of earners account for nearly 50% of consumption, a record. Another datapoint highlighting the growing income inequality that exists in the US.

Now, despite appearances might Trump’s MIQ be, ‘how to solve inequality?’ In other words: his fight may not be ‘left verses right’ as most believe. But ‘up verses down’. Framed thus, one can make sense of his policy of deportation, decreased foreign aid and of course tariffs, aimed at promoting domestic production and jobs. Deregulation may syphon the incumbent’s moat, promote innovation and unlock animal spirits. Lower taxes might, too.

Incentives?

But still, the best idea I’ve seen to unlock wealth, remove inequality and prevent America from tearing itself apart is that of Brad Gerstner’s Invest America initiative discussed recently. Give every kid an opportunity to participate in the upside in America, gear them into the power of compound growth, and incentivize them to increase financial literacy.

That incentive? Skin in the game. It’s an idea I that would love to see the UK, where I live, mimic. For if you want to change the (investment) culture, you?must?change people’s behavior. And the best opportunity for doing so is when they are young.

Mandation

I remain of the view the day will come when UK pension funds are nudged—or outright shoved—into investing in domestic growth assets, creating a "pension put" for markets and reversing decades of capital outflows.

Picture it: a patriotic pivot that transforms pensions into a national growth engine. Perhaps the industry could borrow Sir Keir Starmer’s rallying cry, swapping “Country First, Party Second” for “Country First, Pension Second.” Torsten Bell, the pensions minister, even hints at such a future in his book, Great Britain? How We Get Our Future Back. It reads like a blueprint. Increased liquidity in UK equities seems inevitable, so staying ahead of the curve might be wise.

While you wait, why not enjoy a dividend that beats bonds? Or take inspiration from TV personality Jeremy Clarkson’s tale of a football manager who promised his struggling team would rise “like a pheasant from the flames.”?

When he was corrected to “phoenix,” the manager shrugged: “Whatever. I knew it started with an F.”

Whether pheasant or phoenix, it’s likely going to be good for the FTSE.

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