With volatility across equity markets on the rise, it’s prudent to take a step back and assess the situation from a big picture perspective.
The recent volatility has largely emanated from the US where the NASDAQ index, which is dominated by high-flying growth stocks across the technology and biotech sectors, succumbed to strong profit taking pressure. The combination of stretched valuations and fund positioning has fuelled the recent selling.
US funds have been relatively neutral on the broader market but overweight growth stocks, and this trade has worked well for quite some time. For example, since the bottom of the GFC the NASDAQ 100 index is up 230 per cent versus 168 per cent for the broader S&P 500.
After performing strongly into the 1Q14 highs, growth stocks retreated sharply as funds took profits and reweighted their portfolios back towards non-growth sectors.
The growth stock trade was a crowded trade, meaning a lot of the funds had similar positions. When they all headed for the exit door at the same time, volatility rose sharply.
This volatility has spread to our shores, with expensive growth stocks witnessing a strong bout of profit-taking. These include names such as REA Group (REA), Seek (SEK), CarSales.com (CRZ), Vocus Communications (VOC), TPG Telecom (TPM) and IProperty Group (IPP), just to name a few.
There has been a lot of talk about the bursting of the technology bubble in 2000 and whether we could be witnessing a second coming. Whilst anything is possible, there are a number of key differences that indicate a repeat event is unlikely.
Broad market valuations are nowhere near as stretched as they were in March 2000. For example, Cisco, which is one of the standout tech companies, was priced at a P/E of 120 times in March 2000 compared to 15 times now. Tech bellwether Apple is currently priced at 37 times earnings.
Importantly, parts of the market that are perceived as overvalued account for a much smaller portion of overall market capitalisation today than they did 14 years ago. In 2000, the technology sector accounted for 14 per cent of overall S&P 500 earnings and 33 per cent of market capitalisation, while today the sector makes up only 19 per cent of both earnings and market capitalisation.
While the odds are against a 2000-like crash, the impact of heightened volatility is likely to remain in the short-term, especially if you factor in the famous ‘Sell in May and go away’ strategy and its potential influence on the market. The adage refers to the US market, where investors head into the summer vacation season that kicks off with the Memorial Day holiday in May.
Another domestic factor adding to increased uncertainty is the upcoming Federal budget, which is expected to be tough to say the least.
According to the Stock Trader's Almanac, the Dow Jones Industrial Average has had an average return of only 0.3 per cent during the May-October period since 1950, compared with an average gain of 7.5 per cent during the November-April period.
Looking ahead, we still believe we are in a long-term bull market. Those more active investors could look to take some money off the table and buy back in at lower prices in the coming months. For the more long term focused investor, they should look to add to or initiate new positions on share price weakness.
We believe investors should rotate towards large cap yield plays, which are more relatively attractive on a valuation basis. Speak to your advisor for more specific, suitable stocks.
Ben Potter is the retail editor at Baillieu Holst.