Are We Headed For A Market Correction?

On Tuesday morning, I attended a breakfast in the city. It was a ‘think tank’ with a bunch of stockbroker types. The invitation came off the back of last week’s Moowsletter, ‘Jumping at Shadows’.

The breakfast was also conditional. Meaning, you had to bring at least one original idea. You couldn’t just turn up, lean back and regurgitate something out of the paper if pressed for an idea or an opinion. You had to put some meat on the bone.

Everyone’s ideas were pretty much shelved at the front door because as soon as the discussion started, it immediately turned towards the current markets. Namely, are we headed for a correction?

This is how it kicked off…

The ‘Shiller’ P/E Ratio
Someone asked if anyone follows the Shiller P/E ratio (price/earnings), to which a few of us said ‘yes’.

(Coincidentally, two days after our breakfast, BetaShares released a piece on the Shiller P/E ratio as well. It must be this weeks talk of the town).

The Shiller P/E was created by Nobel prize winning economist, Professor Robert Shiller. It’s a metric that has been around for ages and is widely used by a lot of market analysts.

In short, it’s used to determine if stock prices are cheap or expensive, and right now, the Shiller ratio is showing equity valuations (stocks and shares) in the US to be at dangerously high levels. i.e very expensive.

Almost everyone at the breakfast agreed the US market is at nose bleed levels. Then the discussion turned to what would be the likely cause for a correction. Will Trump be the cause or will it be some other geopolitical factor that blindsides the lot of us. Or could it be interest rates?

Will Trump be the cause of a market correction?
Short answer, no! Although he will probably get the blame for it. BTW, I’m not a fan of his.

In my opinion, there is only one thing which causes a market to correct, and that’s investors paying overs for assets in the first place. I.e. Investors willing to pay more for an asset than what’s its worth.

In the US at the moment, investors are paying $1.50 plus for $1 worth of assets. Its nuts!

The market has had a very strong run up of 20% in the past year on the back of Trumps election to office. And whilst 20% is not really alarming, the problem is the market has priced in an expectation that Trump will be able to deliver on all his pre-election promises, especially tax reform.

Trump’s problem is he is not well liked by his own party and loathed even more by the Democrats. He will struggle to get anything through Congress and eventually the market will realise his promises won’t materialise.

The great irony I see around Trump is that the markets believe in him more than the general populous despise him. But eventually that divergence in beliefs may begin to converge as one (possibly).

But that’s just my view, there are thousands out there like it and thousands more who would oppose it.

The Most Important Factor
I don’t know what the catalyst for a correction will be and at the risk of sounding dismissive, it doesn’t really matter. Eventually the catalyst becomes extraneous.

The only thing that matters right now is that US stocks are trading way above what they are worth and will eventually experience a significant correction.

Water always finds its own level.

So what does this mean for the Australian market?

As the saying goes, when Wall St sneezes the rest if the world catches the cold. However, the Australian market is nowhere overvalued like the US market is and so we won’t feel the effects as much as the US market.

That said, if you are sitting on anything that is overpriced, get rid of it.

When Can We Expect A Correction?
If history is anything to go by, it is quite possible we could see something happen in October. Just cast your eyeballs over these dates…

Black Monday, October 1987
Asian Financial Crises, October 1997
GFC, October 2007
2017…?

History may not repeat itself but it sure does rhyme.

Have a great weekend!

Adam

Back Paddock – Happy Father’s Day to all the Dad’s for this Sunday. Here are two Daggy Dad jokes your children will just love hearing from you, probably even expect!

Q. Did you hear about the wooden car?
A. It wooden go.

Q. Did you hear about the steel car?
A. It steel wooden go.

Enjoy your day!