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Why the equity sell-off is short-term only

Glenn Freeman  |  07 Feb 2018Text size  Decrease  Increase  |  
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Even as equity markets around the globe recover from falls of around 2.5 per cent since last week, experts are divided on whether we're seeing a short-term correction or a systemic return of volatility.

Regardless of these views, Dan Kemp, head of Morningstar Investment Management in the UK, reminds investors to maintain a fundamentals-driven approach and try to drown out the noise.

"Periods of market turbulence can be especially dangerous for investors as they tend to elicit an emotional response and heighten the behavioural biases to which we are all prone," he says.

Suggesting three ways to help overcome harmful biases, Kemp says investors should:

1) Remember that investment is a long-term pursuit.

2) Try to avoid the sensational headlines that can lure you into action.

3) Remember that if you are going to look for opportunities, ensure you have a robust framework for setting the real value of assets.

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"And finally, remember that investors tend to make too many decisions rather than too few. So, if in doubt, do nothing," he says.

JP Morgan's chief market strategist for Asia Pacific, Tai Hui, believes the market pullback was entirely foreseeable and views it as "a healthy correction, which we believe is driven by investors taking profit on a strong 2017".

"Given that our positive view on underlying fundamentals remains unchanged, that we see little risk of recession, and that earnings expectations remain strong, we would view this as a buying opportunity," Hui says.

"It's not surprising that higher bond yields are upsetting the equity outlook--we knew that would be a risk in 2018. However, it's important for investors to distinguish between bond yields that are creeping upwards as a reflection of healthy economic growth and modestly increasing inflation--and therefore a positive development--and a bond yield surge that exacerbates volatility and undermines the rally."

Bull markets don't die--they're killed

Hui doesn't believe the current sell-off will lead to an overtly bearish market: "Bull markets don't typically die of old age, they are usually killed by central banks aggressively hiking interest rates."

"Although markets are finally slowly starting to fully price in expectations of interest rate increases from the US Federal Reserve, we don't think central bankers will risk moving too quickly and endanger the recovery they have painstakingly coached for the last decade."

This is a view echoed by AMP Capital's chief economist Shane Oliver. In a note issued on Monday, he suggested the pullback still had further to go "as investors adjust to more Fed tightening than currently assumed--we see four (or possibly five) Fed rate hikes this year against market expectations for three--and higher bond yields".

"This will impact most major share markets, including the Australian share market which is vulnerable given its high exposure to yield plays like real estate investment trusts and utilities.

"However, the pullback is likely to be just an overdue correction, with say a 10 per cent or so fall rather than a severe bear market--providing the rise in bond yields is not too abrupt and recession is not imminent in the US with profits continuing to rise," Oliver says.

He believes a recession in the US is not imminent, and for several reasons including high levels of confidence, given the "post-GFC hangover has only just faded".

Oliver also points to the ongoing positivity in the US Federal Reserve's yield curves, with rates of between 1.25 and 1.5 per cent still well below nominal growth of 4 per cent or more.

"Tax cuts and associated fiscal stimulus" are yet to take effect, and "we have not seen the excesses" such as heightened debt growth, capacity constraints or excessive inflation that usually precede recessions, according to Oliver.

Inflation and valuation

The chief economist of Aberdeen Standard Investments, Jeremy Lawson, refers also to macroeconomic conditions in markets outside the US in arguing recent market moves are short-term only.

"You have to think about what's going on in wage and inflation dynamics outside the United States--the US isn't the only economy that matters here, particularly if you're thinking about the policy environment," Lawson says.

"Underlying labour cost growth and inflation developments in the Eurozone, Japan, and places like Australia--they still remain very subdued. Those central banks aren't in a position where they're going to start to ramp up monetary policies."

Along with growth and inflation, he looks at the valuations of risk assets and says they aren't as stretched as some commentators suggest.

"People have a tendency to want to think about equity valuations ... in an absolute sense, 'Oh, the PE ratios are very high relative to history--this suggests there is an equity bubble or a misallocation'. But you have to take into account the level of the bond yields when you're thinking about equity valuations--it doesn't make sense to think of them in isolation," Lawson says.

"When you think about equity valuations relative to bonds, they don't look cheap, they're slightly on the expensive side of fair value, but not necessarily at a type of valuation that might mean equities can't continue to outperform cash, particularly in an environment where corporate profits have still been surprising to the upside ... our fundamental view is that equity valuations and risk valuations are not constrained."

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Glenn Freeman is a senior editor at Morningstar.

© 2018 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'class service' have been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. Please refer to our Financial Services Guide (FSG) for more information at www.morningstar.com.au/s/fsg.pdf. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782 ("ASXO"). The article is current as at date of publication.

 

is senior editor for Morningstar Australia

© 2021 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This information is to be used for personal, non-commercial purposes only. No reproduction is permitted without the prior written consent of Morningstar. Any general advice or 'regulated financial advice' under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), or its Authorised Representatives, and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information, refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product's future performance. To obtain advice tailored to your situation, contact a licensed financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782. The article is current as at date of publication.

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