Global stock markets have experienced a lengthy upwards surge since the start of the bull run in March 2009, with the MSCI World index – a proxy for global equity markets – returning 176% (or an average of 13.1% per annum) over the period. US stocks have performed particularly well, with the S&P500 index delivering a total return of 316% since 2009 (since the election of President Donald Trump in November last year it has rallied by a remarkable 14%). Extended bull runs do eventually result in short-term corrections, which are a normal and even ‘healthy’ part of the market cycle. Are global markets heading for one now? While we can’t predict shorter term price changes, we believe the risk that the current broad global rally will retract to slightly lower levels, has increased. Here’s why:
- The duration of the current cycle is of increasing concern to analysts and investors alike. Eight years of rising equity markets is not the norm – this is the second-longest bull market since World War II. Historical precedent suggests it’s unlikely that share prices can continue their upward march indefinitely, and a minor correction will therefore not be entirely unexpected.Within this longer term structural cycle, shorter term corrections aren’t uncommon. We’ve seen an uninterrupted climb in share prices for 15 months now. Against this background, a pullback in share prices globally shouldn’t come as a surprise.
- Globally, stocks are trading at elevated price levels relative to their earnings. There are some markets that are slightly cheaper, but most are currently expensive in terms of their own history. And overvalued markets can’t avoid a readjustment forever – they do tend to correct in time to more ‘normal’ levels.
The announcement yesterday by US Federal Reserve chair Janet Yellen to raise interest rates won’t necessarily stop the bull in its tracks – it was largely expected and markets will have already factored in a hike. However, her hawkish comments following lower than expected inflation numbers and uncertainty in terms of how the Federal Reserve will wind down their balance sheet later this year may cause markets to react negatively and push the pause button.
IMPACT ON SA MARKET
A possible short-term correction in global equity markets will naturally not leave our own JSE unscathed. Having said this, the downside risk for a cheaper market is less than for an overheated one, and our market is currently not materially overvalued. Trading at a price-to-earnings (P/E) multiple of 19.7 times, it does appear elevated. But stripping out some of the high-priced big guns such as Naspers, British American Tobacco (BAT) and certain mining stocks, one arrives a more representative P/E multiple for the JSE of around 15 times, which is not overly expensive. So while some of the more costly JSE heavyweights may be vulnerable to a global market retraction, the impact on the broader South African market is unlikely to be significant.
A NOTE ON PORTFOLIOS
What does all this mean for our clients’ investments? At SPW, we’ve already factored a potential market correction into our portfolios. In our balanced portfolios, we’ve trimmed our equity exposure somewhat – we still have substantial exposure to this asset class, but we no longer have the full equity weighting allowed in terms of Regulation 28 of the Pension Funds Act.
From a longer term perspective, a slight market pullback should lead to buying opportunities over the next few months. Price levels are always the most important factor driving prospective returns, and where pockets of value emerge as a result of a market correction, we’ll make use of the opportunities created to add quality shares to our clients’ portfolios.
