5 things to note in this market

By Morningstar Analysts |  02-07-20 | 
 

Right now, the future impact of COVID-19 and its effects on global markets is superlatively important but largely unknowable for investors. This uncertainty may drive some to wish to pull out of the stock market.

If you feel the same, Mike Coop, head of multi asset portfolio management - EMEA, at Morningstar Investment Management, has some advice.

1. Take a moment to reflect over the past 100 years.

We’ve been through World War I and II, over a dozen recessions, a Global Financial Crisis, and a Great Depression, to name a few.

Each of these had unique features and high levels of uncertainty at the time, but each also had things in common with the current crisis—devastating economic impact, global scale, and political upheaval.

While we don’t know how the pandemic will play out, we have seen one of the largest and fastest government policy responses—this has made dire economic outcomes much less likely than in the past. Knowledge about pandemics is also much better.

But as we navigate the tumultuous present, we continue to hear investors ask why the market rebounded so strongly given how bad the economy is, and whether we will see the lows of March retested.

2. There is nothing wrong with uncertainty.

Markets are unpredictable in the short term, yet there seems to be no end to the appetite for predictions from investment managers.

It's not just investing. Anyone who watches sports on television fully knows that

  • the unpredictable seems to happen a lot,
  • humans' ability to predict any short-term outcome is very limited, and
  • we still love to hear and make predictions.

A lot may be said about predictions, but my point is that markets’ future may be blurry in the short term, but less so over the long term. Generally, we believe that economies recover, markets recover, and in the case of today, that the coronavirus will eventually end.

3. Change your focus.

Through market environments, we find that market prices will depart from market fundamentals, or the aggregate cash flows produced by companies.

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 because, again, we believe that eventually assets will be priced fairly, meaning overpriced assets will fall and under-priced ones will rise.

Some of the sectors and investments where we see value today, remain much the same as they were prior to this bout of coronavirus-related volatility—albeit with greater dispersion between the best and the worst. For example, we’re still seeing opportunities in the U.K., Europe, and some emerging-markets equities. Newer opportunities include energy companies, high-yield and investment grade bonds, all of which sold off heavily in March.

4. Don’t get swayed by superficial headlines.

It is important to understand what's within an index, or ‘the market’, 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 well outpaced most other developed-market stocks over the past decade. 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. In other words, demand for their products is less dependent on the strength of the economy.

These points are even more true about the Nasdaq, which is loaded with technology and growth-style U.S. companies. In fact, if we were to characterise these Big Tech firms themselves as a ‘market’ (Facebook, Apple, Amazon.com, Netflix, Microsoft, and Google (Alphabet), we’d see that much of the growth of the entire U.S. stock market since the global financial crisis has been thanks to the success of this handful of stocks.

On July 1, out of the 30 Sensex stocks, 14 closed higher. But it was the rally in RIL and finance stocks that “got the market high”.

The big question for investors is whether a rosy future for these stocks is already priced in or whether these companies can do even better in the future than the past and therefore justify a further re-rating. For many of these market darlings a lot of very good news is already in the price and the scope for disappointment is high.

5. Focus on what you know.

We don’t know when markets will regain their highs, or if markets will retest their lows.

But we do believe that over the long term, companies (and the consumers that buy from them) will adapt and find ways to deliver value.

We also believe that prices will inevitably follow the underlying cash flows of the investment in question. Therefore, we have an anchor we can trust to determine fair value—that is, fundamentals—and need the fortitude to sit patiently until prices reflect these underlying cashflows.

A version of this article initially appeared in Portfolio Adviser.

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