Short and long term market returns are due to different drivers
The recent international market volatility should be seen as a buying opportunity for investors that believe in fundamentals, and understand that fundamentals don’t change in the space of three or four weeks.
In fact the recent volatility is a reflection of some institutional investors getting anxious and wanting to ensure that their money is safe, or so says Juan Nevado – director of strategy and operations at M&G Investments in the UK – who was speaking about behavioural investing and how markets price risk at the Prudential Portfolio Managers investment conference in Cape Town.
The give-away clue, according to Nevado, was the speed with which the markets moved in January, and the massive panic that was evident, especially when one considers that global equities had their highest yield in 15 years, in that month. Global yields went up one percent in one month.
More recently the South African market has moved up 20% in four weeks, following the doom and gloom of January, and yet the fundamentals haven’t changed at all.
Nevado says while the textbook explanation that fundamentals drive the markets is certainly true for the long-term, sentiment and human emotion generally drive market movements over the short-term.
Asset prices over the long-term are a function of economic fundamentals, such as inflation, profits, interest rates and human emotion, but over the short-term it is clear that fundamentals move far less than asset prices.
“It is the impact of investor sentiment on the short-term pricing of assets on the stock market that create the buying opportunities, but these opportunities still need to fit into a long-term strategy.”
The Australian market in January was another case in point. In December their market was neutrally priced. By early January the market was dropping 20% as people started worrying about loosing money, and not because the fundamentals had changed.
If more proof were needed Nevado says that one should only look at that happened to the Thailand equity markets when that government announced the introduction of capital controls – the market fell 18%. The net day the government reacts and reverses the decision and the market rallies, only to drop by 20% a few weeks later, without any change to the fundamentals. The problem was that there was now a perception of riskiness.
January was a classic case of negative feedback, which in effect caused dropping share prices dropping even further. The mental scares are present in investors’ minds, which meant that while profits have been going up, equity prices haven’t increased as much. Investors simply didn’t believe the valuations and pe, expecting the market to crash.
Where does this leave the South African investor?
The bottom line is that investors with a well-diversified basket of stocks have no need to panic. While diversification will not shield investors from market volatility, it makes the inevitable movement of the markets much more palatable and allows room for taking advantage of buying opportunities.