Market Temperature Taking Excercise [Oct 2020]
This is an exercise from the book: Mastering the Market Cycle from which the purpose is to understand the “temperature” of the current market and the implications of what’s going on around us.
Everyone sees what happens each day, as reported in the media. But how many people make an effort to understand what those everyday events say about the psyches of market participants, the investment climate, and thus what should be done in response?
Below is my own interpretation of the current market developments based on my understanding of the market as an investor and my experience with investors as an advisor. I highly recommend that you run through this exercise as well and share with me your opinion!
Economy and Future Economic Outlook
While the current economy is still quite sluggish due to the higher than average unemployment and lower than average consumption/spending as a result of the COVID-19 pandemic, my inference of the market participant’s perception for future outlook is one that is leaning towards a positive story as everyone is betting on the economic recovery.
Capital and Capital Markets
As a result of the central bank’s intervention, capital is of an abundance right now in the markets. Furthermore, given the current market valuations, it makes sense for businesses to IPO or enters into M&A agreement to make use of the market’s receptiveness towards high valuations to lower their cost of capital.
Lenders, Debt Terms, and Interest Rates
Given the current interest rate environment and perceived business risks, I believe financial institutions are not willing to take on uncompensated risks. As such, I believe that they are more selective about who they are willing to lend to and more restrictive with their debt terms.
Investors, Asset Owners, Sellers, Markets, and Yield Spreads.
Over my 7 years of investing, I’ve never encountered a situation where investors are bearish and pessimistic over future market developments but they continue to pour in their savings into the markets in search of higher returns.
There may be a few factors in play, one being greed while the other being the fact that there are really no other alternatives for investors to chase after a higher return rate on their savings apart from actively participating in the markets directly.
Asset Price, recent performance, prospective returns, and risks.
I think its safe to say that we’ve witnessed a very strong recovery/performance since March and as a direct result of that, assets prices and valuations are at their all-time high.
If we’ve learned anything over the last 200 years of market history, it is that when valuations are high, prospective returns will be low while risks will be high.
Moving forward, it is either the fundamentals recover to bring valuations down or prices will correct itself to bring valuations down – in other words, a correction by time or correction by price.
My overall sentiment from the exercise
Based on this exercise, personally, my interpretation is that the markets are slowly inching towards the top of the cycle.
In terms of the question of: “are we there yet”, probabilistically speaking, I do not think that we are “there yet” due to the following reason:
the market cycle doesn’t usually top when the bearish sentiment is high
there is no major external shock that may send investors into a panic and reverse the current bullish feedback loop (learn more about the anatomy of a typical crisis)
As such, I think that there may be still room for the market to rally before we hit the top of the cycle. That being said, it is also important to acknowledge the market headwinds and its potential impact on the fundamentals and investors' sentiment. Key areas to look out for would be:
2nd wave of COVID during winter and potential second lockdown
Ending stimulus and its effects on businesses, employment, and consumption
US presidential election
Moving forward, the key is to have a better understanding of the sustainability of price actions and adopt proper risk management. Depending on your view of the market, you may want to consider cutting back on your exposure to certain markets and re-enter upon clearer signals of a SUSTAINABLE economic and market recovery.
Remember, a 50% loss requires a 100% return to break even, while time in the market is important, sitting back and doing nothing despite clear signals of an overheated market instead of managing your portfolio to reflect a more appropriate risk exposure for your own financial situation is not the right way moving forward.
Clearly, not making a profit beats incurring a loss. When in doubt, remember the first rule of investing: Never lose money.
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Daniel is a Licensed Independent Financial Consultant with MAS and a certified Associate Wealth Planner that provides advice in the following areas:
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This article is meant to be the opinion of the author and is for information purposes only.
This article should not be seen as financial advice
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