How to profit from today’s market volatility
When markets head south, it’s a time for investors to rejoice and not despair. Because falling markets give you the chance to invest in quality businesses – often at knock-down prices. So, my advice right now is to make the market correction your ally, remembering that the lower the price you pay, the higher your long-term return is likely to be.
Last week, U.S. inflation data revealed the pace of price increases remained both stubbornly and unexpectedly high in August, driving Wall Street to its worst day of losses in more than two years.
Headline inflation peaked back in June at 9.1 per cent year-on-year, fell to 8.5 per cent in July and in August fell again to 8.3 per cent. But that was not enough to assuage investors and economists who had expected a lower figure of 8.1 per cent, and were therefore wrong.
The August inflation figure was aided by lower fuel prices but a continuing surge in price for food, housing and medical care categories disappointed.
I remain of the view that inflation in the U.S. has peaked. That’s a good thing, but it will take longer than the bulls expect to get down to the Federal Reserve’s intended target of two per cent.
Therefore, when the market gets excited about inflation peaking, you should zip up your wallet and wait. The market will inevitably be disappointed again. And when the market slides on the disappointment, you should be sharpening your pencil ready to invest in the high quality companies and funds you have had your eye on.
We should not be surprised by continuing volatility in the near term because the market remains fearful of inflation taking its time to ease and of the Federal Reserve’s commitment to reducing inflation amid a tight labour market. The latter means rising rates for longer than consensus recently expected.
I believe early signs are confirming inflation is peaking. Store inventory levels are high, as are wholesale inventory levels. Days-to-deliver and backlog-of-orders have also peaked, suggesting the trend is in the right direction for the price of goods that had hitherto suffered from supply chain bottlenecks.
But the service sector makes up a large component of Core Inflation and salaries are, in turn, a large component of services prices. U.S. wage growth is at its highest level in decades suggesting the Fed is no-where near pausing rate increases. While the labour market remains tight, it’s simply premature for the market and investors to be excited about falling inflation.
The market is vulnerable to episodes of disappointment
The tight labour market will eventually resolve itself. First however, international flights need to be cheaper for workers to be able to afford to migrate, work, and alleviate the tightness so many companies are complaining about.
In the meantime, the combination of aggressive Fed tightening, and fragility in the economy, means investors might reasonably expect some mouth-watering value to emerge among high quality companies.
While the Fed raises rates there is risk the economy falters. Fed Chairman Jerome Powell warned the world to expect some pain. In any event, fiscal and monetary largesse has given way to restraint. This should dampen aggregate demand. And company earnings of course are a coincident with GDP, so as the economy slows you can expect the proportion of the companies reporting declining earnings to rise. Those companies should see more material share price falls. But they’re not the companies we are investing in.
Rob Forker from Polen Capital’s Global Small and Mid Cap Fund told me that even though the share prices of his portfolio have fallen in aggregate by 38 per cent, the earnings of the portfolio have risen 15 per cent. The further they fall in price the better the buying. As Ben Graham once suggested; “buy stocks like you buy groceries, not like you buy diamonds.”
The point of this blog post is not to elicit concern but to inspire you to be ready to take advantage of opportunities. The lower the price you pay, the higher your return – especially when the companies you buy are growing their earnings at double digit rates!
We also know bull markets always follow bear markets. There will be a dawn. Remember Ben Graham’s urging to take advantage of Mr Market’s wallet rather than listen to his wisdom? You can read the Mr Market Allegory here when, in 2018, as the market then corrected, I wrote about making market corrections your ally.
The good news is that inflation is ever so gently easing. It is not contracting as fast as an impatient stock market would like, and there’s some concerns about the state of the economy, but that’s when opportunity abounds. Be greedy when others are fearful and fearful when others are greedy, remember? It’s when sentiment is disappointed and glum that bargains abound.
And historically – at least since 1970 – when the economy is growing, even slightly, and disinflation is occurring (‘disinflation’ is consecutively lower rates of inflation) – growth stocks do well.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Peter Ralph
:
Thanks for clarifying, Roger, much appreciated. I ran a capital equipment business in the eighties where the average price of our products was $150,000. We were close to a monopoly and much to our customers’ angst we updated our price list every three months. It feels the same now. I know you were only using it as an example but if we go from 8% this year to 7% next year I think it would be a disaster. The RBA is going to have to go far harder and it would be less worrying if MacFarlane or Stevens’ hands were on the wheel. I don’t know which is the most misleading word of the twenty-first century… unprecedented or transitory?
Roger Montgomery
:
good points Peter.
Peter Ralph
:
“I believe early signs are confirming inflation is peaking.” I’m guessing you don’t do the supermarket shopping, Roger. The latest PPI and CPI numbers out of the U.S. hardly support your belief. When I see “peaking,” I immediately think “transitory” and we know how that worked out. This country has been blessed with some great RBA governors … the incumbent is not one of them. We were late to the party with interest rate increases and remain well behind the ball … when Jacinda Ardern is increasing faster and harder than us you know something’s not right in the state of Denmark. I hope you’re right but I doubt you are.
Roger Montgomery
:
Hi Peter,
I do the grocery run frequently. Coles, Woolies, IGA, Harris Farm, you name it, I’m there making sure we ignore the blueberries at 12.99/pn and buy heaps . You can find me I am not saying prices are declining – that would be deflation. I am talking about disinflation – a slowing in the pace of price increases. Prices will still rise but I believe at a slower rate. Of course I could be wrong. The ABC’s Four COrners program last night is a reason to expect local inflation to persist as labor supply pressures keep local wages elevated and local jobs secure. Other indicators globally however such as the drop in ‘days delivered’ and ‘backlog of orders’ indicate the inflation pressures from supply back bottlenecks are easing. When I say “Peaking’ I am not referring to prices. I am instead referring to the pace of change in prices. To be clear, I am saying that if inflation is 8% today, it should be lower next year (7% perhaps or 6% or 5%), and then 5% or 4% or 3% maybe the year after. Of course, the outcome will be dependent on whether we have a soft or hard landing economically and what the central bank’s response is to that… So many moving parts and therefore impossible to forecast with any accuracy. Hope that clarifies for you Peter.