Markets around the world have fallen sharply so far in October, shaking investors out of their comfort zone. Why is this happening?
In my view, it’s very simply a question of gravity – the US equity market has been on a diverging trajectory from reality: stocks have been hitting peak valuations as corporates have been reporting peak profitability, whilst the clouds are gathering on the horizon.
The evidence is there in the valuations: as of October 25, the US was on a PE ratio of 22.8x and a P/BV of 3.5x, a 19% and 35% premium to the 10-year average respectively, and at a significant premium to international markets.
The US economy was already doing well, then it was boosted by an unprecedented tax cut, further fuelling short-term profitability. But that tax cut is a one-off event, the new tariffs on imported products and the oil price recovery over the last year have resulted in growing inflationary pressures. Hence the Federal Reserve has had to respond with an acceleration of the interest rate cycle.
With inflationary pressures growing, an increasing number of corporates are guiding profitability expectations downwards for 2018 and 2019, citing the negative impact of rising costs and the burgeoning tariff war.
International markets appear to have been reflecting this scenario more accurately year to date and now the shakeout would seem to have finally arrived Stateside. Investors now need to understand that the rocket fuel has run out and the coming year or two will prove much tougher for the real economy.
As long-term fundamental investors, we continue to see attractive opportunities in every sector and region, irrespective of the prevailing conditions. Moreover, we believe this environment of macro-driven uncertainties helps to underline the benefits of stock-focused portfolios based on in-depth research and regional expertise, rather than those which are dictated by macro factors or market-directional strategies.