The sight of slumping stock prices hasn’t shaken most market strategists’ confidence that the bull market still has further to fly. But they warn investors to buckle up – we could be in for plenty of turbulence.
In the wake of a selloff that has knocked the U.S. benchmark S&P 500 stock index into official “correction” territory (a drop of more than 10 per cent) in the space of a month while lopping 7 per cent off Canada’s S&P/TSX composite, strategists on Wall and Bay streets are reminding clients that the size of this correction is nothing out of the ordinary in a post-recession bull market. What’s more, they insist that the selling is being driven by fear rather than fundamentals – meaning that markets with solid growth prospects are merely getting cheaper and creating buying opportunities.
“It is difficult to be very bearish of corporate assets when growth is reasonably strong, inflation is low, margins are expanding, monetary policies are easy, and valuations are undemanding,” said economist Larry Hatheway of UBS Ltd. in London.
“In the first four months of this year, investors had become increasingly complacent to risk,” he said. “This was a market vulnerable to correction – all that was missing was a catalyst.”
However, that catalyst – a major sovereign-debt scare out of Europe – has re-awakened investors’ hyper-sensitivity to risk, a lingering effect of the credit crisis of 2008-09. The depth and speed of this risk adjustment does suggest that even if stocks can track generally higher in the coming months, they may do so in a very moody, volatile way.
“People are now a lot faster on the trigger in reducing risk. This increased volatility could be a byproduct of a new way of managing portfolios,” said Stéfane Marion, chief strategist at National Bank Financial in Montreal.
“But we have to keep things in perspective. We haven’t yet seen the collateral damage [from the European debt woes] that would upset global growth.
“In a world where credit markets remain functional, I don’t think the amount of selling we’ve seen can be justified,” he said. “The valuations we have right now are very reasonable.”
George Vasic, chief strategist for UBS Securities Canada Inc., noted in a research report that over the past 50 years, post-bear-market rallies on the Toronto Stock Exchange have all been met with corrections on the scale of what we’ve seen recently; the average pullback has been 13 per cent. Similarly, Pierre Lapointe, global macro strategist at Brockhouse & Cooper Inc. in Montreal, said the S&P 500 has routinely rallied in the year after the end of a recession, yet those rallies have all included a considerable correction within them, averaging 17 per cent.
“The next few months will remain volatile, but history tells us that the year that follows a recession is usually very profitable for equities,” said Mr. Lapointe, who reiterated his overweight recommendation on global equities.
David Bianco, chief U.S. equity strategist at Bank of America-Merrill Lynch in New York, is among several strategists who issued research notes in the past few days reiterating their earnings and stock-index targets over the next 12 to 18 months. His 12-month target for the S&P 500 remains at 1,350, a whopping 25 per cent above Tuesday’s closing levels.
He said the current S&P 500 levels imply a price-to-earnings multiple of about 12 times, far below the historical norm of 15 times. At normal P/Es, current levels are pricing in S&P 500 earnings of just $72 (U.S.) a share for 2011 – almost 20 per cent below Mr. Bianco’s “base-case” forecast, and toward the low end of his worst-case projections in the case of another global recession.
“Times like this make it clear that the risk equity premium is no free lunch, and volatility is gut-wrenching, even for the most long-term investors,” he said. “[But] we believe the best way to feel better during a correction is to buy some shares.”
