Are we naive for wanting to believe in fairy tales? Surely no one would rather believe in the worst possible outcome? Mankind is inclined to believe that all things will turn out for the best, but does this belief system apply to investments as well? When looking at a graph depicting the last 50 years’ movements on the JSE/All Share Index, the answer is, absolutely. The general trend is upwards and corrections are usually relatively short-lived.
Before I continue, however, I think we should just briefly discuss the definition of a correction. Although there is no real concrete definition for a market correction, among stock brokers, it means a 10% or greater decline from the market’s peak levels. In today’s terms, that would mean a decline to levels of around 48 150 and lower from its current levels of around 53 300. This may seem like an inconceivable drop, but the reality is that the FTSE/JSE All Share Index has experienced at least 11 corrections of 10% or more since January 2000.
It may sound like a lot, but it isn’t all that strange an occurrence. Everyone refers to the last 3 years’ movement on the stock market as sideways, but many do not realise that we have experienced two corrections of 10% or more in the last 24 months alone. We remained optimistic, however, and quickly eliminated short-term losses by rapidly moving back to previous highs.
But as important as it is not to be driven by pessimism when it comes to investing in shares, investors should also caution against becoming overly optimistic. Always remember the following two important factors when considering an investment in shares:
Firstly, you should always have realistic expectations and secondly, remember that the SA stock market is but a small fish in a vast ocean. To illustrate this, let’s use the largest share/company in the world, called Apple. Like many other companies following this past week’s trading, Apple reached new heights, and at a current market capitalisation of $777 billion, it is almost 2.5 times the size of the current South African annual GDP.
When looking at the vast ocean as a whole, I think it’s clear that optimism is currently a very powerful driving force behind the market. In my column dated 30 March 2017 (How low volatility can increase your investment risk), I explained how too much optimism managed to force the volatility index (VIX) of the Chicago Board Options Exchange (CBOE) very close to those dreaded 10% levels. I also mentioned that every time that percentage fell to below 10%, it was seen as one of the greatest buy indicators in history. Without many realising it, that percentage fell to below 10% a few times this week, posing the question: where to now?
No different to the SA market (trading above a price-earnings ratio of 20 times), the S&P 500 is currently trading at a PE of 25 time versus its historical average of 16 times. Surely it can’t be healthy to assume that they will just keep on reaching new heights? I agree that it’s nothing new that we are now trading at more expensive levels, but what worries me is that 81% (according to a recent BoFA Merrill Lynch survey) of fund managers in the USA currently feel that stock markets are trading at levels that are too expensive.
That doesn’t mean that we are nearing the end, however. Joseph Fahmy, managing director of Zor Capital, recently released a report in which he compared the movements of the S&P 500 between the corrections of 1987 and 2009. Although the reasons for the two corrections vary greatly from each other, it was quite interesting to see that the two graphs look almost exactly the same. If history should repeat itself, a final run in the stock market may be more likely to happen before we see the next correction.
No one knows if this time will really be different. John Templeton said, the four most dangerous words in investing are ‘this time it’s different.’
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for any actions taken based on the information contained in this blog.