Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 328

How much will you risk to feel comfortable?

If you were to look only at headline indices, you’d be forgiven for believing that we have been living through one of the longest bull-runs in history. In Australian dollar terms, the S&P/ASX200 price index is up 41% over the past 10 years, while the MSCI World and the S&P 500 have jumped 153% and 268% respectively.

But, if the world’s stock markets are doing so well, why do so many investors seem so anxious?

A few big stocks have driven returns

It turns out they have good reason. While the headline indices look good, it is only because of a few US mega stocks that have done exceptionally well over the period. If you look at an equal-weighted version of the index, instead of the more common market capitalisation-weighted index, the average stock globally has been mired in bear territory for over 18 months, while the top 50 US companies have done significantly better.

In order to understand this unhappy bull market and where it might be headed, we need to go back to 2009.

Gun shy in the wake of the GFC, many investors took a safety-first approach. They filled their portfolios with assets they could trust and, more importantly, understand. As a result, government bonds and bond proxies, blue chip shares with recognisable names and stable share prices did well.

As interest rates fell closer to zero, quantitative easing continued and growth remained elusive, so the fears engendered by the subprime explosion that started everything were replaced by new worries. What if growth never returns? What happens when central banks turn off the liquidity taps? What has happened to productivity? These worries helped to push bond prices even higher and the price of stocks that were perceived to be safe or that demonstrated any kind of fundamental growth higher still.

From 2016 came added uncertainty

And that was before 2016. Before Britain was divided by Brexit. Before the rise of populism in Europe and before Donald Trump began his mercurial presidency and led the US into a trade war with China.

Since then, the steady flow of money into what have traditionally been considered safe assets has turned into a flood. As the world has felt more uncertain, so the value of near-term certainty has skyrocketed. What had begun as a reaction to the recklessness of 2008 now borders on the ridiculous. And, there is no better example of this than the bond market.

Investors are now buying bonds at prices so high that they are guaranteed to make a loss if they hold the bond to maturity. More than US$17 trillion of bonds are trading at negative yields. Some of the buyers of these bonds are central banks, whose goal is to push down yields, and some are banks and life insurance companies who are compelled by regulatory or timing issues to do so.

But other buyers are just anxious, so uncertain about the future that they would rather make a small, guaranteed loss than put their money into something perceived to be more risky. Of course, for many the hope is that they will be able to sell the bond to an even more anxious buyer before it matures. That kind of thinking defeats the purpose of buying a bond in the first place – which is, the theory goes, the certainty that even in the worst case at least you get all of your money back.

Safety rather than fundamentals

This anxiety also permeates stock markets and has resulted in the unhappy bull market this story started with. The shares that have driven the index have been a mix of bond proxies with well-behaved share prices and those that have performed unusually well over the past four years.

In a world characterised by uncertainty these stocks have been comfortable to own and, as such, highly prized. Low volatility and momentum stocks trade at a 24% and a 47% premium to the broader market respectively.

Put another way, stable, established firms like Coca Cola trade at a Price to Earnings (P/E) ratio of 33 times, a level usually associated with fast-growing newcomers, while Netflix, for example, one of the stocks that has set the market alight in recent years now trades around a P/E ratio of over 100. Investors are willing to pay more than 100 times its current year’s earnings to own its shares.

And that is where the problem comes in. The criteria by which many investors are choosing stocks at the moment has everything to do with how comfortable it feels to own them and very little to do with the fundamentals of the businesses involved.

A P/E of 33 would be justified if Coke’s business was booming, for example, but it isn’t. While the drinks maker is still selling a huge number of soft drinks, its revenue line is stagnant and it is paying out all of its profits and piling on debt to meet its dividends. Likewise, while Netflix’s latest quarterly earnings report showed that it had grown revenue 26% year-on-year, justifiable questions can be asked about how likely it is that growth will continue at such a pace, especially with new players including Apple and Disney moving in on the streaming video action.

This is not the first time that markets have been driven by factors other than fundamentals, nor will it be the last. But it is important to acknowledge that it is happening. Currently, the market seems to be asking investors one question: How much are you willing to pay to feel safe? And the answer they appear to be giving is: a lot. Perhaps a better question to ask is: How much are you risking in your quest to feel comfortable?

 

Charles Dalziell is Investment Director at Orbis Investments, a sponsor of Firstlinks. This report constitutes general advice only and not personal financial or investment advice. It does not take into account the specific investment objectives, financial situation or individual needs of any particular person.

For more articles and papers from Orbis, please click here.

 

RELATED ARTICLES

Where to put your money these days

Market narratives are seductive and dangerous

Finding single-digit PE stocks in an overvalued market

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.

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?

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.