Your Quarterly E-Zine
Edition 11 • December 2019

This website contains the latest edition of Forsyth Barr Focus, a quarterly on-line magazine written by senior members of Forsyth Barr's investment team.

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EYES WIDE OPEN

Since the bottom of the Global Financial Crisis (GFC), investing appears to have been easy, with record highs being regularly set by global sharemarkets.

In reality, there were a few missteps in terms of sharemarket growth in the period coming out of the GFC and more recently in the quarter ended 31 December 2018. Understanding sharemarket “value-for-risk” (or the degree to which some shares or sharemarket sectors were over or undervalued) helped investors to manage the volatility during this period. Equally clear, however, is the extent to which market “momentum” (or investor demand for shares) has also boosted overall sharemarket performance.

To determine whether or not to stay invested in shares, investors need to understand what has been driving market performance and if the “fundamentals” (or the data behind a company’s share price performance) continue to support value-for-risk.

Companies defined by analysts as having “momentum” characteristics, are identified by analysing both their earnings forecasts and share price momentum. The former should support ongoing price appreciation, however the level and pace of price appreciation needs to be kept in perspective.

Putting prices into context with earnings expectations, today we find that some valuation fundamentals are challenging, with forward price-earnings (or PE) multiples for momentum companies now at record highs, both in absolute and relative terms. The fact that relative PE multiples are outside the usual band suggests that investors need to be reviewing the shares of “momentum” companies they hold. The behavioural theory behind share price momentum is analogous to the colloquial “frog in the pan” hypothesis, and in some cases, there is the risk that the frog may be well and truly cooked!

Having noted the elevated prices of some shares, market “momentum” can continue. Passive share investment (where investment is spread across all shares in an index) is playing a more significant part in determining how long market momentum can persist. In the United States, total funds invested with passive equity managers now mirrors that invested with active equity managers. Investments made by passive share funds don’t consider the fundamental value of shares in an index.

While funds-flow into sharemarkets can influence shorter-term performance outcomes, a company’s ability to deliver earnings over time also matters. Looking at so-called “market-darlings” (or companies favoured by investors) since the GFC, those companies that have continued to appreciate in value have delivered earnings growth. Those that haven’t have lost their favoured status.

The last point to note is that share price returns for companies considered to be “market-darlings” tends to be better as they become popular. The median return among the companies classified in this group since the GFC was +26% p.a. in the two year lead-in period. It was less than half of that (+10% p.a.) in the subsequent two year period.

Investors always need to consider whether or not the best market returns are already behind them, but also importantly, what are the risks of negative returns looking ahead.

 

Brian Stewart
Senior Analyst, Strategy

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