Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 240

Volatility and reflecting on the inflection

Initial selling during a heavy share market fall has nothing to do with valuations, and that is why it is always difficult to judge the extent of any short-term correction. With a bit of space from the immediate ructions of last week, what did it tell us about the long-term position of debt and equity markets?

Finally, a reaction to rising rates

Having watched this sort of thing far more than I’d like, my summary is this: it was an interesting but not unexpected week with a technical adjustment in markets. It was investors finally reacting to the fact that interest rates are adjusting to the reality of stronger economic growth and a US central bank that has begun the process of removing excess liquidity from the system.

Eighteen months ago, I thought that we had turned a corner not yet recognised by the broader market. Interest rates had inflected. Few people thought the same, particularly given the lack of wages growth in the US and the fact that interest rates were still negative in parts of Europe.

Scaling the wall of Fed money

The Federal Reserve monetary base since 1950

In September 2016, I expressed a view in our quarterly report that investors should note how abnormally low rates are (and remain so now) and not to allow the gyrations of the market to hide the fact that the tide may be changing. We thought the inflection point had occurred in July 2016 and there would be a different set of long-term opportunities in future.

Our expectation was that economic growth and earnings would be better than expected and the short-term price action risk would now more likely come from inflation scares and subsequent upward moves in interest rates.

Between then and now, we have invested based on our belief that markets were underestimating how tight labour markets were, with the most common complaint from CEOs in the US being the inability to find workers. Coupled with the passage of Trump’s tax cuts late last year, which in theory will create significant pent up demand, interest rate markets have noticed that the inflection point had already been reached.

Flow into bonds at the expense of equities

However, investors (particularly passive ones) have been still piling into bonds at the expense of equities.

Until recently, the lack of wage growth was still a popular theme. This was looking in the rear-view mirror. Then we saw the strongest year-on-year increase in US wages for some time and market sentiment turned on its head and interest rates appeared to trigger a technical reaction in equity markets.

I suspect it is simply further confirmation that excess liquidity is starting to leave the system, the most high-profile examples being through VIX funds and even Bitcoin. Investment opportunities will now be in those companies that can grow their earnings, as opposed to those that historically benefited from a re-rating on the back of lower interest rates.

Investment opportunities, but with some cash caution

Many forecast valuation multiples seem reasonable. As examples, home builders are trading at less than 10x forecast earnings, banks and alternative asset managers at 10-12x and Pfizer is 11x. Over 50% of our global portfolio is on an average price to earnings (P/E) ratio of approximately 11. Other large sectors and stocks, as monopolistic and high growth businesses like the financial exchanges, Mastercard, Visa and Google range in P/E ratios from 18-24x, which seem reasonable for the nature of their businesses. We believe these types of businesses will give a satisfactory return in a general market environment of lower returns and choppier price action.

With last week’s pullback in the market, we marginally reduced some of our futures hedges, closed out short REIT positions and will, in all likelihood, marginally increase some of our existing positions. This will be done within an overall framework that interest rates have inflected, markets have done well, and an invested position of approximately 85-90% is prudent.

 

Paul Moore is Chief Investment Officer at PM Capital. This article is general information and does not consider the circumstances of any investor.

RELATED ARTICLES

Will the RBA cut rates before the Fed?

4 ASX small caps poised for a big year

Rates higher = shares lower… is it that simple?

banner

Most viewed in recent weeks

Are term deposits attractive right now?

If you’re like me, you may have put money into term deposits over the past year and it’s time to decide whether to roll them over or look elsewhere. Here are the pros and cons of cash versus other assets right now.

Uncomfortable truths: The real cost of living in retirement

How useful are the retirement savings and spending targets put out by various groups such as ASFA? Not very, and it's reducing the ability of ordinary retirees to fully understand their retirement income options.

Is Australia ready for its population growth over the next decade?

Australia will have 3.7 million more people in a decade's time, though the growth won't be evenly distributed. Over 85s will see the fastest growth, while the number of younger people will barely rise. 

How retiree spending plummets as we age

There's been little debate on how spending changes as people progress through retirement. Yet, it's a critical issue as it can have a significant impact on the level of savings required at the point of retirement.

20 US stocks to buy and hold forever

Recently, I compiled a list of ASX stocks that you could buy and hold forever. Here’s a follow-up list of US stocks that you could own indefinitely, including well-known names like Microsoft, as well as lesser-known gems.

The public servants demanding $3m super tax exemption

The $3 million super tax will capture retired, and soon to retire, public servants and politicians who are members of defined benefit superannuation schemes. Lobbying efforts for exemptions to the tax are intensifying.

Latest Updates

Property

Financial pathways to buying a home require planning

In the six months of my battle with brain cancer, one part of financial markets has fascinated me, and it’s probably not what you think. What's led the pages of my reading is real estate, especially residential.

Meg on SMSFs: $3 million super tax coming whether we’re ready or not

A Senate Committee reported back last week with a majority recommendation to pass the $3 million super tax unaltered. It seems that the tax is coming, and this is what those affected should be doing now to prepare for it.

Economy

Household spending falls as higher costs bite

Shoppers are cutting back spending at supermarkets, gyms, and bakeries to cope with soaring insurance and education costs as household spending continues to slump. Renters especially are feeling the pinch.

Shares

Who gets the gold stars this bank reporting season?

The recent bank reporting season saw all the major banks report solid results, large share buybacks, and very low bad debts. Here's a look at the main themes from the results, and the winners and losers.

Shares

Small caps v large caps: Don’t be penny wise but pound foolish

What is the catalyst for smalls caps to start outperforming their larger counterparts? Cheap relative valuation is bullish though it isn't a catalyst, so what else could drive a long-awaited turnaround?

Financial planning

Estate planning made simple, Part II

'Putting your affairs in order' is a term that is commonly used when people are approaching the end of their life. It is not as easy as it sounds, though it should not overwhelming, or consume all of your spare time.

Financial planning

Where Baby Boomer wealth will end up

By 2028, all Baby Boomers will be eligible for retirement and the Baby Boomer bubble will have all but deflated. Where will this generation's money end up, and what are the implications for the wealth management industry?

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.