Recent stock market volatility has some investors now wondering what the future might hold for their investment portfolio and whether they should be making changes. Why investors should be worrying more about this now, after a period of volatility, than they were two months ago is somewhat of a mystery.
No-one seems to mind upwards volatility, it is only downwards volatility they don’t seem to care much for.
Volatility goes both ways
It is always intriguing how many refer to “volatility” when what they really mean is declining share prices. No-one seems to mind upwards volatility, it is only downwards volatility they don’t seem to care much for.
When the S&P 500 had positive total returns each month in 2017, after several years of strong returns, many investors seemed not to worry even though this pattern has never happened before. When the positive momentum continued into 2018, with the S&P 500 up almost 6% in January, one of the strongest starts to a year ever, investors seemed content rather than concerned.
Much of this emotional response we can put down to fear of missing out or FOMO. Investors can be prone to increasingly reckless behavior when they see other investors making money. Nowhere has this been more evident recently than in speculative bubbles such as Bitcoin, which increased in price by 1,318% during 2017 with much of that gain in the December quarter.
Are investors ignoring risk?
While such speculative bubbles are not broad based, it is a worrying indicator of a potential shift in investor mindset and a gradual eroding in the recognition of risk. While economies around the world appear to be in good shape and companies are investing and growing earnings at robust rates, major global equity markets are near all-time highs. The S&P 500 is in the 98th percentile of ‘expensive’ based on the Shiller CAPE 10-year price-to-earnings multiple (current stock prices divided by average 10-year earnings adjusted for inflation) with only the dot-com era exceeding current valuation levels.
The increased stock market volatility of the last two months may suggest, perhaps belatedly, heightened anxiousness about current valuation levels and what that implies for future long-term returns. Yet, the lure of short-term returns and the fear of missing out are powerful forces. In the light of these forces, the memory of what has happened in the past can start to dim. In our view it is important to maintain investment discipline and not chase overvalued or inferior businesses just because their share price is going up in the short term.
A poor outlook for equities
While valuation is a poor predictor of short-term returns, it is an excellent predictor of long-term returns. From the current elevated market levels we believe the long-term outlook for equities, as a whole, is poor. Current valuations for the broad market suggest investors should be expecting well below average returns over the next decade.
From the current elevated market levels we believe the long-term outlook for equities, as a whole, is poor.
Additionally, much of the recent strong performance of equity markets and index driven ETF products has been as a result of the extraordinary performance of a narrow band of technology stocks. Should those technology stocks start to come under pressure, as we are currently seeing with Facebook following yet another scandal concerning Facebook’s treatment of its user’s data, then passive index driven investment products may disappoint investors.
All is not doom and gloom
We firmly believe that there are still opportunities to safely and productively put capital to work in select companies that have good prospects for compounding underlying value but are trading at prices that do not reflect that growing value. The mismatch between price and value is often the result of short-term factors affecting a company, industry or region.
Perhaps, after a long bull market in which low-cost passive investing has increasingly seemed the best way forward, we are about to re-enter a world in which broad equity market exposure fails to meet investor expectations and yet active managers, who follow a disciplined, bottom-up stock picking process, still have a chance to deliver attractive returns.
Avenir Capital is a value-based investment manager that brings a long-term, owner-oriented approach to global public equity markets. For further insights from the team, please visit our website
Adrian is the Managing Director and Chief Investment Officer of Avenir Capital and is responsible for the portfolio management of the Avenir Global Fund. He holds a Master of Business Administration (MBA) from Harvard Business School.
value investors are always saying the outlook for shares is poor. more often than not they have been wrong.
Investing strategies for market cycles = Value -> Growth -> Momentum -> Value and the cycle repeats. Since we are all sitting on the Momentum phase now, might be prudent to listen to the value guys. Especially since traditional valuation models are based on a mechanism that is currently expected to "Revert" to the norms - Risk-Free Rate. Valuations likely to be much lower than current models predict depending on whether we see a sharp reaction to increasing rates. Let's see who's wearing the pants when the tide recedes.