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Why we’re still waiting on a correction

A look at the earnings per share growth on a rolling year-on-year basis shows this measure is at strong levels perhaps indicating fear around an overvalued market might be a little over blown, at least in the short term.



While investors of all stripes wait with a mix of fear and anticipation for possibly long overdue global equities market correction, Matthew Hopkins, AMP Capital Multi Asset Fund’s senior portfolio manager, is seeing things in a bit more of a positive light.

Sure, the clear and present danger from the overt geopolitical risks is real – an escalation of conflict resulting from North Korea’s weapon testing is a real looming threat.

A meaningful fall in asset price valuations could be sparked by an event of this magnitude, and experts have been predicting this for a while including AMP Capital’s own investment professionals here and here

But behind the fear, evidence is strong that fundamentals – earnings and economic growth – are supportive of share price valuations in global share markets at current levels, Hopkins highlights.

“Of course you can’t time a correction; the United States being drawn into the situation in Korea means the risks are going up. But if you’re looking at the market from a fundamental point of view, for the past year, earnings have come through and valuations at these levels on a whole are justified,” Hopkins says.     

We’re actually in a bit of a sweet spot right now, Hopkins notes. 

He explains that the benefit of lower inflation expectations is a more dovish US Federal Reserve and a lower US Dollar. All of this means easier financial conditions and an environment the still low level of real rates are helping companies to grow their earnings and support valuations globally. 

A look at the earnings per share growth on a rolling year-on-year basis shows this measure is at strong levels perhaps indicating fear around an overvalued market might be a little over blown, at least in the short term.

For some assurance that economic growth is supportive of valuations at current levels, the Purchase Managers Index (PMI) is a good economic indicator to look at too, Hopkins notes.

It’s clear to Hopkins there is a lot of fear in the share market – and perhaps for good reasons given the politics,  – but he suggests some of this fear might be misplaced.

Fundamentals relating to growth and earnings stemming from the overall stimulatory global economic environment means volatility is exceptionally low.

There’s nothing really to fear looking at the numbers in the near term, Hopkins points out. 

Preparing for the “overdue” correction in global equity markets is one thing, but working to the fundamentals is as important, he says.  

“You can hedge those [market correction] risks at the margin – we could be short [selling] the Korean Won, we could be [holding] long the Japanese Yen. But we’re not taking a lot of risk out of the portfolio because the market hasn’t run away from the fundamentals yet,” Hopkins explains.
   
Investment firms and individuals sitting on the sidelines holding cash, the large amounts of demand for bonds – these are tell tale signs investors are preparing for a correction and have been for some amount of time.

The stretched relative pricing in volatility markets is  another tell tale sign investors are perhaps too cautious and are underplaying th strength of the data that’s supporting and indeed justifying valuation multiples at current levels.

“People are paying a lot for protection now relative to what they pay for the upside. The price of buying a call option, relative to a put option, is at all time highs in some markets. As a dynamic asset allocator with an eye on these fundamental indicators, this presents an opportunity for us,” Hopkins says.
Funds related to this article: Dynamic Markets Fund

Navigating the ups and downs of the market cycle. This fund uses dynamic asset allocation to actively adjust the split of investments across asset classes to achieve diversification in response to market changes.

The Fund aims to achieve growth above inflation1 and smooth out the economic cycle over a rolling 5 year basis.

1Consumer Price Index (CPI) - the Reserve Bank of Australia inflation rate, trimmed mean

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