Investor emotions: Leave it to the professionals in a crisis
Optimism has passed the point of euphoria. Timing the market can be hazardous
INDICATIONS that investor emotions will soon change to anxiety are increasing by the day.
Investor emotions are well-documented by market observers such as Barry Ritholtz.
Although highly subjective, an overlay of the market emotions cycle on the MSCI World Index from 2003 provides some insight.
We are at the stage where investors’ optimism has passed the point where they were euphoric that the above-average returns would continue for ever. The euphoric stage was the feeling good stage when investors faced maximum financial risk.
Turning points in the markets are mostly event-driven, such as US President Donald Trump’s trade policies and sanctions. The anxiety caused by the events makes investors unsure as to where the market is heading next and they opt to rather sit it out. Currently the behaviour of the financial markets indicates that investors are increasingly turning more risk-averse.
They are shunning emerging market assets, consumer staples are no longer underperforming the markets, gold is outperforming emerging market equities in terms of US dollars, while long dated bonds in relatively weak developed economies such as Italy and Greece are taking a pounding. And for good reason, too. According to Markit Economics the rate of expansion in the global manufacturing sector as measured by the JP Morgan Global Manufacturing PMI (purchasing managers’ index) has been in a down trend since the beginning of this year and fell to a new two-year low in September.
Growth in the manufacturing sector in China, the world’s second-largest economy, has stagnated, while longterm government bond yields in the US overshot on the upside, indicating that the Fed may have to act sooner and more aggressively to stem economic growth and keep future inflation in check.
A major concern to me is that the month-end values of the Chicago Board of Exchange’s S&P 500 volatility index (Vix), popularly known as the “fear factor”, has been in a down trend since its highs in 2008 during the global financial crisis.
Although the trend line has been exceeded momentarily, chartists will tell you that a major breakout of the down trend is in the offing in the not too distant future. Higher volatility is normally associated with declining equity markets and the high volatility can be very uncomfortable for investors.
Whatever event may cause the Vix to break out on the upside – the sanctions imposed on Iran, Trump’s impeachment, the escalation of the trade war or the US elections in November – actions by central banks may alleviate fears of investors and volatility may subside and the equity bull market resume.
Failure to do so may impact negatively on consumer and business confidence – the main drivers of US and global market valuations as measured by Professor Robert Shiller’s Cyclically Adjusted Price Earnings Ratios may head south, resulting in diminishing capital values.
If price declines continue, a bear market may appear on the radar screen, as investors may start to panic. Some investors may capitulate and withdraw from the market, while others become despondent and ask themselves how they could be so wrong. That is the stage when investors are at the point of maximum financial opportunity.
The anxiety or risk off stage could not have come at a worse time for South Africa and South African investors. The confidence crisis is deepening, but the main question is: what has already been priced in in the market values of South African equities and other asset classes? Timing the market can be hazardous; rather leave it to the professionals.