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Is this a bubble bursting?

Glenn Freeman  |  08 Feb 2018Text size  Decrease  Increase  |  
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Investors should consider recent events in global markets through the lens of price versus fundamental change, says Morningstar's Clint Abraham.

To help explain the pronounced market reaction and "look through" the noise, Morningstar Investment Management Australia's portfolio specialist, Clint Abraham, notes the irony of the US situation.

Pointing to the falls across US stocks listed on the Dow Jones, S&P 500 and tech-focused Nasdaq, he says: "ironically, if market headlines are to be believed, this was in reaction to stronger employment figures released last Friday, where the market is now thought to be concerned that the jobs figures are too good and will force the central bank to raise interest rates faster and higher than predicted".

"Following the swift change in sentiment, global markets have fallen sharply, with European
and Asian markets deteriorating amid the volatility spike.

"Making headlines are the short-term moves in Japanese equities, falling by nearly 5 per cent from peak to trough, while the FTSE is down almost 6 per cent, Europe down 5 per cent, emerging markets by approximately 4 per cent, in local currency terms, and the Australian market down more than 3 per cent," Abraham says.

 

Exhibit 1 The U.S. equity decline in perspective


chart


Source: Morningstar Investment Management calculation, Morningstar Direct to 05/02/2018

 

Referring to the above chart, he notes there have been "very few periods of genuine market stress over the last couple of years and, secondly, in the context of history, the magnitude of losses is less significant".

"Bond markets have also experienced heightened volatility, with interest rates on 10-year
Treasury bonds rising rather sharply on Friday (to 2.84 per cent), only to reverse on Monday as
investors rushed to take advantage of the lower price and higher yield.

"This phenomenon was extended globally--and among currencies--as investors attempt to make sense of the ramifications of strong wage growth and the potential for higher inflation," he says.

How investors should interpret this

"One must remember that the jobs figures showed the highest wage growth in eight years, not the weakest. So, it seems rather ironic that it was the sole catalyst for investor panic, as it is something the market had desired for so long.

He highlights this as a clear example of the difficulty of applying rational processes to explain sentimental shifts, "and reinforces the need to focus on valuations".

"Under this framework, it is important to look through why the investor reaction was so pronounced, which is best considered under the lens of price versus fundamental change.

"Is the market reaction more to do with the nervousness extending from the stellar bull market of 2009-2017? Or can we expect a material impact to corporate profitability?

"While we are not in the business of forecasting short-term sentiment, we can
look at current prices, where US equities have been considered as overvalued for some
time now.

"We can also apply thought to the evidence, which overwhelming shows that
prices are more likely to fall back in line with fundamentals, especially when prices run well
ahead of intrinsic value," Abraham says.

In the context or recent events, he also points to the wisdom in the following quotes from some of the best investment minds of recent generations:

The ability to focus attention on important things is a defining characteristic of intelligence.

Robert Shiller

Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Warren Buffett

Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria.

Sir John Templeton

What action Morningstar is taking

Morningstar's Abraham emphasises the need to acknowledge that periods of market turbulence can be especially dangerous for investors, because they can elicit responses based on emotion rather than rational analysis.

"The Morningstar Investment Management team will be spending the next days, weeks and
months watching the developments closely in this context.

"However, we will be focusing on the same principles as we would any other period; assessing the value of each asset class, digging into the fundamental drivers of returns and challenging the fear/greed corollaries that we are all behaviourally exposed to," he says.

He highlights that the elevated levels of cash held in Morningstar's portfolios--in response to stretched valuations--should serve a two-fold role in buffering against current volatility and providing "ammunition should any exemplary opportunities present themselves".

"We appreciate that many are nervous about the current market conditions, yet it is important that we stick to our plan and focus intently on the objective at hand.

"We similarly advocate that one remembers the tenets of great investing; to be thoughtful, be long-term focused and be willing to challenge our own behavioural biases," Abraham says.

"While this is nowhere near as exciting as making quickfire trading decisions, it reflects our
observation of how the most successful investors operate."

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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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