Is a market crash around the corner?

Is another market crash around the corner?

This may well be the most popular question today, or at any point in the last 12 months. The simple answer is yes, a market correction (a fall of 10 per cent or more) or crash (a fall getting on for 20 per cent) is always around the corner. But the real question is, does it really matter?

If the last twelve months have shown anything, it is that markets, investors and the media have never in their history been more short-term focused. I may well be contributing to this via my daily investment update, but it seems the news and media cycle has shortened to just a few minutes.

Back to the subject at hand, which is an impending crash in the sharemarket. Just like at any point in the last 20 years, or in history for that matter, there are enough reasons to warrant going to cash today. The list is endless, including the ballooning spread of the Delta COVID-19 variant, saddening events in Afghanistan, continued border closures, Chinese regulatory pressure, higher commodity prices and the apparent threat of inflation.

But are we really going to sell everything back to cash and accept near-zero returns or income? If you have $20 million in retirement that may well be an option,  but for the rest of us, compounding returns are key.

If there were ever a better example of the fact that timing the market is a fool’s errand, it was last year. The Coronavirus outbreak stumped even the most experienced and successful investors.

There were a limited few who “saw it coming” selling out beforehand and protecting capital. Yet very few of these people were able to successfully deploy capital in that two-day window before the market rallied, ultimately resulting in below-average returns.

There were those who saw it coming and did nothing, choosing to remain invested and ultimately delivering 20 per cent-plus returns in line with the index. And finally, those who didn’t see it coming but took a long-term view and bought quality companies at more reasonable prices. Not surprisingly, it was this final group that performed best.

There has been huge growth in the cohort of self-directed investors in Australia, where we have the unique ability to manage the entirety of our retirement capital ourselves. This is rare across the world and something I see as a responsibility, not a right. This flexibility allows investors to avoid some of the biggest issues that face many experienced fund managers.

For instance, as it stands today, the consensus among professional managers seems to be that the ‘recovery trade’ is alive and well, with a strong economy and policy stimulus supporting cyclical sectors including financials, energy and commodities. The result is that many managers are buying cyclical companies en masse.

Why? Ultimately, because they have to. The majority of managers are measured against their benchmarks on periods as short as one to three months, with any “underperformance” flagged immediately. The result is that many can simply choose not make too large a call on a popular sector or trade, or risk underperforming and potentially losing funds to invest.

This is why we constantly read about ‘cyclical’, ‘value’ or ‘growth’ rotations in the market as they are seeking to capitalise on the latest trends. It is also why the majority of research is now incredibly short-term focused.

By no means is this a bad thing; rather it makes sense to have hard working managers seeking to capitalise on every opportunity that arise within a broader portfolio of assets. What it does provide, though, is opportunity for those with longer investment horizons and ultimately more patience.

For those able to take a three- to five-year view, there has never been a better opportunity to add exposure to high quality names like CSL (ASX: CSL) or Apple (NASDAQ: AAPL), stocks that you may well never sell. With all eyes on the cyclical rotation, these defensive growth names, delivering both revenue and profit growth, are in the unloved basket.

Consider, for instance, that you can buy Apple today on a backward looking price-earnings (P/E) ratio of 29 times earnings, dropping significantly on forecast earnings, but are paying as much as 45 times to purchase ARB Corporation (ASX:ARB) the distributor of aftermarket 4WD vehicle parts and accessories. It’s solid business, no doubt, but is this a company you want to own post the pandemic?

This was a point made by one of my favourite managers, Nick Griffin of Munro Partners, who recently highlighted that the ‘value’ or ‘cyclical’ rotation is simply a trade, meaning it is inherently short-term. It is not investing. At the end of the day, you end up with the same commodity or energy company you had before, that remains solely driven by the price of an underlying commodity that is out of its control.

There is a similar consensus building on inflation, with most flagging the simple mathematics of higher monetary and fiscal stimulus ultimately resulting in inflation. It’s that simple, right? Every piece of real evidence, in my view, suggests rates will remain lower for the foreseeable future. Little has changed in our economy outside of a short-term sugar hit from fiscal stimulus, with the world looking more like Japan, than post-WWII America. 

Sure, if you review your portfolio on the assumption that interest rates will hit 5 per cent, it is clear that there will be pain everywhere from residential property to sharemarkets, and we would likely be in a recession. The more important question, however, is how certain are you of that outcome? And is it worth betting the farm on the result?

Clearly not.

Despite this, it clear that a market correction lies ahead at some point in the coming months, volatility is sure to increase, and any number of catalysts could cause this. In my view, this should be seen as an opportunity, not a threat. Having an appropriately balanced portfolio, not one switching from one ‘trade’ to the next, will ensure you are well prepared to capital on the events that follow.

Personally, I will be looking to: 

• Top up some quality domestic and global names including Commonwealth Bank (ASX: CBA), Magellan Financial Group (ASX: MFG), CSL, Wesfarmers (ASX: WES), Apple and Microsoft (NASDAQ: MSFT);
• Increase exposure to those regions with the most supportive government backdrop, being Asia and (potentially) Europe;
• Add some traditional fixed-income ahead of what may well be a bumpy few years for the economic recovery.

Drew Meredith

Drew is publisher of the Inside Network's mastheads and a principal adviser at Wattle Partners.