OCBC OneWealth App– No reason to be bearish

Equities

Global

Outlook

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Vasu Menon

Executive Director, Investment Strategy, Wealth Management Singapore, OCBC Bank

No reason to be bearish

12 May 2021

The recent volatility in stock markets has spooked some investors and led to fears that we are on the cusp of a sharp correction and possibly a bear market.

These fears are unfounded, and investors should not lose sight of the medium to long term outlook, which remains positive.

Markets may be volatile, and we could even see a short-term correction, but there are no indications that we are at the start of a bear market. Certainly not, when economic and earnings recovery appear to be underway, the vaccine rollout is progressing quite smoothly, and liquidity remains abundant.

The Federal Reserve also continues to reassure markets that it is too early to tighten policy, and any pick-up in inflation over the coming months would be temporary because of last year’s low base.

What’s behind the recent market volatility?

Concerns about rising inflation and fears that it may cause central banks to pull the brakes on ultra-loose monetary policy have caused jitters and market volatility.

Tech stocks, which have led the recent rally, have borne the brunt of the volatility, with the Nasdaq index down about 6% from its peak in April this year.

These stocks have rallied since March last year, and their less than attractive short-term valuations has contributed to the volatility and correction in the tech sector.

Also, rising bond yields have impacted longer-dated assets more than shorter dated ones. Tech stocks are often viewed as long-dated investments, and therefore are more vulnerable to rising yields.

Bond yields have increased sharply this year, with US 10-year government bond yields rising from 0.9% at the start of the year to as high as 1.74% at the end of March, before easing to 1.62% now.

Inflation expectations have also been on the rise and this has resulted in the futures markets generally pricing in an earlier than expected monetary policy tightening by the Fed, despite reassurance by the central bank that it has no such plans.

The Fed’s ultra-loose policy and near-zero interest rates have contributed to the stock market rally. Concerns that the Fed may tighten policy sooner-than-expected is a key reason for the recent bout of volatility as well.

Markets seem to be getting ahead of themselves with inflation worries. While we see bond yields rising further, we think that the sharp gains are behind us. We see US 10-year yields increasing to 1.90% - a low level historically - as the Fed is likely to refrain from raising interest rates for several years.

Is it time to get out markets and stay out?

The answer is a clear NO.

History shows that rising bond yields and Fed rate hikes may cause market volatility in the short term, but if the economic and earnings outlook are still improving, then markets can continue to head higher.

It is normal for investors to feel nervous and worry about equity bubbles after a very strong V-shaped rally in stock markets, especially among tech stocks.

Despite the rally over the past 14 months, we think that stock markets can head higher.

For one, there is still a lot of liquidity on the side lines. Also, as the vaccine rollout gathers pace and as economic recovery gathers momentum, investor-confidence should pick-up further and this should help stock markets to head even higher.

However, it does not mean that we won’t see intermittent pullbacks in markets. Occasional corrections are normal and healthy, even in a bull market. They allow markets, which have been on a tear, to catch a breather before resuming their uptrend.

If you look at the global equities rally last year, based on the MSCI World Index, it was interspersed by 6-8% corrections on three occasions. However, these pullbacks did not signal the end of the bull market. Instead, on each occasion, global equities regained its footing and resumed its uptrend, after a brief pullback.

No equity bubble

Looking ahead, the outlook for global equities is still good and we do not see a bubble, at least not for the broader market.

There are excesses in some segments of global equity markets, but the problem is not widespread.

Eventually, the markets are driven by fundamentals and valuations. The good news is that the outlook for economy and earnings is good, and valuations are generally not excessive.

Also as mentioned earlier, there is also a lot of idle liquidity which can offer market support. In the US for example, there is more than US$4 trillion sitting on the side-lines in Money Market Funds and this is a huge source of liquidity for Wall Street and global equities.

Monetary and fiscal policies are also very supportive of markets. Both the US central bank and the US government for example, have unleashed massive stimulus measures over the past year - and they can do more if necessary.

If the Covid-19 situation improves, and more and more people get vaccinated - the investment outlook will improve even more, and this can fuel further market upside.

What about a tech bubble?

Investors may remember the dotcom bubble in 1999/2000, when tech stocks rallied sharply at first and then plunged after the tech bubble burst.

So, it’s understandable that they are nervous now about the tech sector, as many tech stocks have done exceptionally well in the past few months helped by Covid-19.

Nevertheless, we feel that tech stocks should remain a core part of investors’ portfolios.

Technology is poised to drive major and transformational changes in the way individuals and businesses operate in the coming years and even decades.

Technology is clearly a multi-year theme and unlike the dotcom bubble which burst in 2000, the tech-rally this time around is backed by much stronger fundamentals.

For those with a strong risk appetite and a long-term investment horizon, tech stocks can still offer attractive returns, and sharp pullbacks can present buying opportunities.

Stay invested & stay diversified

In a nutshell, we do not see a bear market for equities and the tech sector, and there are no reasons to be overly negative.

Instead, we see more upside for stock markets in the medium term and remain broadly overweight on equities.

The road ahead may not be smooth because of intermittent inflation and infection jitters, but these fears should not derail the medium-term upside trajectory.

For those nervous about short-term market volatility, a good way to manage risk is perhaps to space out fresh investments over a few months instead of investing a lump sum and trying to time the markets.

Timing markets is a risky exercise as we have seen over the past year when equity market defied Covid-19 fears and headed higher. Trying to predict the market’s twists and turns is a tricky exercise and can result in investors missing the boat.

For prudence, it is important to have a diversified investment portfolio comprising a mix of different asset classes. The exact asset allocation will clearly depend, among other things, on one’s risk appetite and time horizon.

Investing in a unit trust is good way to get a diversified portfolio, and a good risk management strategy.

For those with a strong risk appetite, allocating more of their investments to equities still makes sense at this juncture.

While growth stocks like technology stocks have taken the lead in the rally over the past eleven months, going forward, value stocks -- which are beneficiaries of the cyclical economic recovery -- look set to play catch-up. This is the equities segment we are more positive about in the coming months.

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