What drives share prices?
Good day
What is the take away from above? In the short term, emotions drive everything and fundamentals go out the window. Over time, the inverse happens. Given that we focus on fundamentals and are in this for the long term, we won’t let emotions drive our decision making process.
Volatility has picked up noticeably in recent weeks, with rather large swings higher and lower. To make matters more painful for portfolios, bond prices have moved lower, suggesting they have not offered the kind of diversification benefits investors have come to expect.
Global equity markets have had a poor year thus far. Periods of market weakness are not uncommon. In fact, the U.S. equity market, which is the most widely followed, has averaged at least one sizeable decline (10% or more) every year since 1975, with the average fall being nearly 20%. So…a correction once a year and close to a bear market over same time frame. Seems like a tough thing to avoid. Yet, the U.S. equity market still managed to generate a positive annual return in 35 of the past 46 years. Dealing with market volatility is part of the investing experience. We manage your money with this concept in mind - that a 10% decline is always lurking around the corner.
What you may be asking is whether the declines year-to-date signify the start of something potentially more serious that would cause a durable impact to the future trajectory of the global economy and the path of corporate earnings. After all, these two factors, which themselves are intertwined, tend to be the predominant drivers of longer-term equity returns.
Inflation expectations have indeed been creeping higher. This explains the relatively aggressive actions undertaken by central banks who have been raising interest rates rather forcefully. Yet, there may be some relief on the horizon. Recent inflation readings in the U.S. have hinted that growth in core prices, excluding food and energy, may be on the verge of starting to slow. In other words, inflation may remain elevated but close to peaking, marking an important change in trend as we move into the second half of the year. There is a misconception that the economy is tanking yet most data points are positive and…central banks don’t raise rates in a struggling economy.
Equity markets have been under pressure, but so too have bonds. In fact, bond markets have had one of their worst starts to a year. While it’s easy to focus on the poor returns of late, there is a silver lining. Given the sell-off in global bond prices, the yields offered by government and corporate bonds have risen meaningfully. As a result, there is now an opportunity to lock in future returns in fixed income that are significantly higher than levels seen over the past decade. Many investors had shunned fixed income in recent years because of very low yields. However, the potential for future returns from the asset class has now arguably changed, for the better.
Periods of market turbulence, such as the current one we are experiencing, can understandably cause some angst. Yet, it’s a relatively normal phenomenon that occurs from one year to the next. The key risk remains whether inflation becomes entrenched in the expectations of businesses and consumers. This is something that you know I will be watching this closely. In addition, the odds of a U.S. recession which remain low for the time being.
I was online the other day and saw a headline that was along these lines: “Some Person You Have Never Heard of Says a Recession Imminent”. showed it to my wife, Sue, who is rather nonplussed by these sorts of things. I like to know what she thinks about financial news in the mainstream press. She asked if we should be worried. I told her to continue reading and the first line of this so called news story was less shocking. The expert / fortune teller was suggesting they see a recession coming at the end of 2023 / early 2024. Her reaction was twofold: This is imminent? And who can make forecasts two years out? Please…ignore all these shocking headlines. They add zero value to the investment process.
Enjoy your week,
J. Todd Kennedy, CIM, FCSI
Senior Portfolio Manager
613-566-4582