Many seem to think this bull market’s giving investors a wild ride lately. We wonder if they’re thinking of a different bull. Source: Matt Roberts/Stringer/Getty Images.
You’d think markets have ridden the world’s longest rollercoaster lately, given how often volatility fear has hit headlines. Yet stocks haven’t been any bumpier than usual. Sure, August was down, but daily gyrations seemed fairly calm (save a few outliers). Investors broadly seem focused on fears—like taper terror or currency gyrations in far-flung locales—so focused they're not seeing stocks are off only a few percentage points from recent cycle highs. (The MSCI World, for example, is down 2% from its August 2 high.*) That's not great, folks, but declines of that size are run-of-the-mill in any market cycle. Yet headlines scream, "STOCKS SUFFER WORST DAY/WEEK/MONTH IN 2013." The words, "CREATING A GREAT BUYING OPPORTUNITY" don't follow. In our view, that’s one more sign of the disconnect between too-dour investor sentiment and fine market reality.
Volatility isn’t bearish—or at all predictive. Irregular ups and downs are normal for stocks (and bonds and pretty much any investment). On a daily basis, volatility can be pretty, well, volatile. Like Benjamin Graham famously said, “In the short run, markets behave like voting machines, but in the long term they act like weighing machines." Voting machines measure sentiment—investors’ emotional reactions to new policy proposals, jitters about global tensions, excitement or fear over yesterday’s gains or losses, what have you—which can change on a dime. Hence the near-constant jumps and dives. Over longer periods, however, wobbles appear to even out as markets weigh fundamentals.
These days, sentiment—investors’ emotions—is stuck between skepticism and optimism. Markets reflect that tug of war in the near term. But over time, markets have a slew of positive global economic data to weigh. US banks are strong, with clean balance sheets and rising profits. Housing is steadily recovering. America is more or less awash in energy resources, thanks to the shale revolution. Corporate profits are at all-time highs and rising. Overseas, the UK’s services just hit a six-year high, manufacturing is improving, retail sales are growing and loan growth is seemingly stabilizing—and QE’s over! That’s a huge bullish precedent for the eventual end of QE in the US.
More forward-looking indicators globally like LEI, falling inventories and rising new factory orders suggest growth is poised to continue. Yet investors have overlooked many of these fundamentals, focusing instead on headline fears. Like volatile volatility! Meanwhile, a more clear-sighted view of global markets reveals the MSCI World Index is up 140% since the beginning of this bull!** But most folks focus on the wobbles and ignore the (fundamentally supported) long-term growth.
Dour sentiment is keeping markets from fully weighing fundamental reality. When investors eventually realize reality is (much) better than they’ve expected, false fears will flip to rational optimism, and stocks should get a nice lift. As folks gain more confidence in future profitability, the more they’ll pay for future earnings.
It’s a gradual shift and likely plays out for some time. Historically, bull markets end when euphoric sentiment outpaces reality, and euphoria seems nonexistent today. Volatility could very well persist as emotions bounce around from day to day. But there doesn’t appear to be a catalyst for material fundamental weakness over the foreseeable future—risks exist, but they’re either widely discussed or misinterpreted. So as sentiment gradually lifts over time and fundamentals stay bright, markets should feel a nice tailwind.
*Source: MSCI World Index, from 8/2/2013 to 9/5/2013.
**Source: MSCI World Index, from 3/9/2009 to 9/5/2013.