Have the markets become too negative?
Amid the relief rally which followed US Federal Reserve chief Jerome Powell’s conciliatory comments on interest rates (4 Jan), one thing Powell said seemed somewhat curious.
He observed that markets were ‘well ahead of the data’ in pricing in downside risks. While in one sense this was worthy of note, given he was speaking in the aftermath of a very strong US jobs report, in another he need hardly have pointed that out, given markets are always ‘ahead of the data’.
After all, ‘the markets’ are made up of a multitude of trades by countless individual investors all of which are taking a view on how the future will pan out.
It is crucial that every investor understands this point as it is how a business is likely to perform in the future, not how it has performed in the past, which will dictate the future direction of its share price.
Another thing to bear in mind is that markets are not always 100% efficient and will often overshoot on both the upside and the downside. We discuss the value opportunities this can create for investors in this week’s main feature.
This tendency to overshoot creates the possibility that market sentiment has become too depressed through a period which on Christmas Eve saw every sector but one (the traditionally defensive consumer staples space) on the S&P 500 trade in ‘technical’ bear market territory. This is defined as being more than 20% down on their most recent high.
TIME FOR AN UPGRADE?
A recent report from the strategists at investment bank Morgan Stanley suggested that two of the three elements required for an upgrade to its market view were in place.
They note that valuation ‘has been improving rapidly’ with equities as an asset class looking cheaper after the correction, with the forward earnings multiple for global stocks now below 13-times.
Further they observe that sentiment is ‘cautious, but not extreme’ adding that net bullishness of US retail investors is the lowest since 2009, something they describe as a good sign.
The only sticking point is fundamentals or in other words what’s happening in the real world. They comment: ‘Cheaper prices and more bearish investors raise the chance of a bounce. But any sustainable rally will need fundamental support. And here is where the challenges remain most serious.
‘Investors aren’t cautious without reason; there are serious problems that have carried over from 2018 to 2019, some of which are still underestimated on Morgan Stanley forecasts.’
Still, the team believe a number of things could happen to change the fundamental picture and provide a catalyst for shares.
These include: compromises in the face of market weakness from the Trump administration on government funding and trade; a more market-friendly approach from the US Federal Reserve; stimulus from China; only a modest reduction in US growth; ‘ok’ fourth quarter earnings; and the UK avoiding no-deal Brexit while European growth rebounds.
They see a chance of at least some of these occurring by the end of the first quarter and Shares will itself be keeping close tabs on all of these areas in the weeks ahead.