When is the stock market correction coming?

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By Julian Beaumont


One question seems to be top-of-mind for investors these days: When is the correction coming?

The question generally comes with the presumption a correction is due soon, and this in turn reflects caution among investors.

Just as investors feel loss twice as much as a win, it seems human nature is to normally focus on the risks far more than the opportunity.

For example, predictions of a crash are far more prevalent than those of a boom, yet usually you cannot have one without the other.

The global financial crisis seems to have left us with deep psychological scars that are still yet to fully heal, as evidenced by somewhat elevated levels of risk aversion.

In the US, investors have favoured bonds over equities, as fund flows continue to attest.

In Australia, investors have found safety in housing and in the stockmarket safety has been found in quality, yield and the momentum behind whatever has been most recently working.

The Australian stockmarket continues to climb a wall of worry. This is best observed in the gradual and lengthy grind higher since the global financial crisis.

From the lows of the GFC nearly 10 years ago – at which time the market was not much higher than where it started out this century – the market has risen just 95 per cent, equivalent to 7 per cent growth per annum, and still sits about 10 per cent below its 2007 high.

Understand the present

Many still worry that another GFC could hit soon. But lightning rarely strikes in the same place twice, not least because we have a tendency to fight the last war.

This was best illustrated by Mario Draghi’s vow to do “whatever it takes” in the face of the euro crises in 2011, arguably the closest the world saw to a relapse.

In the meantime, regulators have lifted banks’ prudential capital and liquidity requirements, and in general, corporate balance sheets have significantly de-geared and lengthened term maturities. The likes of Babcock & Brown and Centro Properties are nowhere to be seen.

 To expect another GFC is to imply it is a naturally recurring event. But what was the precedent for predicting the last GFC? Or for that matter the dot-com boom and bust? And why draw the comparison for the FANGs and assume they follow the same path?

Market pundits are fond of quoting Mark Twain, that “history doesn’t repeat, but it does rhyme”. But to illustrate using the GFC as an example, there is a big difference between a depression and recession.

Choosing which one greatly distinguished investors and how they fared coming out of the GFC. We cannot know for sure what the future holds. What we can do, however, is understand the present.

In contrast to what one might think by reading the media headlines and expert commentary, markets are actually quite orderly and reasonable most of the time. This is not to say they can’t then have their up and downs, as unpredictable as they are.

 The Australian market has had two corrections of 20 per cent or thereabouts in its rise of 95 per cent since the depths of the GFC. It is fair to say, however, that stocks will recover from such falls and chart back up with the market’s natural long-term rise higher.

Time in market key

In rare instances, however, markets can stretch to their extremes, when excessive euphoria or despair takes hold. Unfortunately, most of us will have got caught up in the boom only for doom to take advantage.

For a boom, it will generally be when the conversation at barbecues or with Uber drivers always comes back to stocks, our friends’ big win causes us too much envy not to partake, we invest on margin, and ultimately, valuations detach from fundamentals.

 In the end, booms and busts require a group effort. Thus, literally only a handful of unique individuals depicted in The Big Short movie truly saw and positioned for the GFC.

In our view, the Australian market is at its normal orderly self. Indeed, stocks actually look relatively attractive. Trading on an earnings multiple of just under 16 times, the market is only slightly above its historical average of 14-15 times.

Meanwhile, cash, bonds, property and most other asset classes sport valuation metrics far above historic averages. And as confirmed by the recent earnings season, stock fundamentals look solid, with aggregate earnings growth last financial year of 8 per cent, and another 7 per cent expected for this financial year.

But more telling, investors are asking when the correction is coming? Reflecting this sentiment, cash levels in equity fund managers’ portfolios are at their highest levels in 18 months, according to Bank of America Merrill Lynch’s recent investor survey.

Given the superior long-term returns of equities over cash, this amounts to a bet against the odds and an attempt to predict the unpredictable.

As Peter Lynch of Fidelity fame once said: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

As the old adage goes, it is time in the market rather than timing the market that works.


First published in the Australian Financial Review: https://www.afr.com/markets/equity-markets/when-is-the-stock-market-correction-coming-20180921-h15pbr