Is the stock market rebound overdone?
By Keith Speck | 28 July 2020
SUMMARY: Portfolio Specialist at Morningstar Investment Management Europe, Keith Speck, looks at some of the commonly asked questions from investors in light of the pandemic and why the answers are not always so clear cut.
We regularly receive questions from our clients about why the market is doing so well, given how bad the economy is, and whether we will see the lows of March retested.
They’re good questions, but they might not have clear-cut answers. We'll discuss three points imbedded in the questions.
Markets are unpredictable in the short-term
This point is obvious, yet there seems to be no shortage of appetite for predictions from investment managers. It's not just investing - anyone who watches sports knows that a) the unpredictable seems to happen a lot, b) humans' ability to predict any short-term outcome is very limited, and c) we still love to hear and make predictions.
In the short-term, one should be prepared for a wide range of outcomes in markets. Yet, we are often surprised at what markets do. Being surprised implies a level of confidence in our expectation, that is probably misplaced. So, not only are markets unpredictable in the short term, we are also overconfident in our predictions.
With investments, we try to keep a humble confidence about the long-term path of markets. History has shown that market declines are eventually repaired by rebounds and that the general direction of stocks in aggregate is up, as long as their underlying companies are profitable, and managements continue to allocate capital so that its growth compounds. The path however is far from smooth.
We do find that market prices will depart from market fundamentals. When prices are below what we think a stock or market is worth, all else equal, we'll typically find that to be an attractive investment. This doesn't require accurate short-term predictions.
Markets predict the economy
Bill Miller, the famous value investor who founded Legg Mason Capital Management, observed that markets predict the economy rather than the economy predicting markets. Economic data is historical - it's backward-looking - while markets are forward-looking. This explains why markets typically rebound before a recession is over, but it certainly doesn't mean markets are always right.
Is it true today? Have markets correctly priced the economic impact from COVID-19? We just don’t know. We do believe, however, that buying assets when they're attractively priced is usually well-rewarded. Also, doing so removes the need to be right about predictions. Even if markets test new lows, we can have a certain confidence they'll eventually recover, and assets bought at attractive prices will do well - regardless of whether they were bought at the most attractive price or not.
A market is more than an index
The idea of "the market" is a tricky one, and what we say about a market can depend on how it's defined. So, it's important to understand what's within an index before you talk about it - or invest in it.
Popular indexes like the S&P 500, for example, don't tell the full story about the investable universe. This “market” has outpaced most other developed-market stocks. This market also has become increasingly dominated by companies that are doing well in the current environment because they benefit from work-from-home consumers or are internet-related, have strong balance sheets, benefit from globally diversified revenues, or their businesses are defensive by nature (meaning demand for their products is less dependent on the strength of the economy).
Most other “markets” are down, some by a lot. So, while it feels like some parts of the market are doing too well currently, other parts are pricing in some negative outcomes and for some, outright disaster.
For more information on Morningstar Investment Management Europe’s views and services, call 0203 107 2930, email email@example.com, or visit our website www.morningstarportfolios.co.uk.
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About Morningstar Investment Management Europe Ltd
The Morningstar Investment Management group, through its investment advisory units, creates investment solutions that combine award-winning research and global resources with proprietary Morningstar data. With about US$217 billion in assets under advisement and management as of Sept. 30, 2019. It provides comprehensive retirement, investment advisory, and portfolio management services for financial institutions, plan sponsors, and advisers around the world. The Morningstar Investment Management Group comprises Morningstar Inc.’s registered entities worldwide. In the UK, Morningstar Investment Management Europe Limited is authorised and regulated by the UK Financial Conduct Authority to provide services to Professional clients.
Keith Speck is Portfolio Specialist at Morningstar Investment Management Europe