The idea of a “V”-shaped stock market recovery was fuelled by expectations of a “V”-shaped economic recovery. This was not an unreasonable assumption based on the shape of previous recoveries that have followed steep declines, coupled with the encouraging early pace set by some of the world’s biggest economies in 2009 and 2010.
But because the financial crisis triggered no ordinary recession, it now seems logical that this is turning out to be no ordinary recovery. Key economies were quickly out of the blocks – notably Germany and the US – and gave comfort to investors looking for signs of a quick turnaround. But they have since lost virtually all momentum after stumbling at the third or fourth hurdle.
Many people now expect some developed economies to slip back into recession while some now argue that we never left it at all. Considering that none of the major developed economies have regained the level of output they reached before the crisis began, you can see their point.
But it is not all bad news and there is a growing sense among some investors that despite all the doom and gloom, perhaps even because of it, this is a great opportunity to take a contrarian position and capitalise on some particularly attractive valuations.
So where are the opportunities for investors who are swimming against the tide? First on the list should be companies that remain able to grow sales and earnings in spite of the lower growth environment. There are plenty of companies capable of doing this across a real cross-section of the market.
Finally, avoiding weaker sectors is often as profitable as buying the strongest. So if your base case is that the recovery never really put down sustainable roots in the first place, you would have been surprised at the pace of recovery in the mining and other cyclical industrial stocks over the past two years. These tend to perform better late in the economic cycle and rely on conviction in the strength of the recovery to outperform.
The recovery has threatened to be weak and bumpy for some time, but confidence in demand from emerging markets overcame concerns about fragility in developed markets. The oil price, for example has remained relatively high, so too has copper and other important commodities. This pushed margins to the upper end of their historic range and valuations in the sector to a peak of 60-year highs on the price-to-book measure.
There is little doubt that the long-term growth in demand for finite commodities remains in tact as emerging markets expand, but the short-term expectations must now be lower as a reflection lower of rates of growth in many countries in the developed world.
Rarely has the market remained this volatile for this long but the last time it happened was so recently, many investors are accustomed to it. This does not mean that all investors behave rationally, however. This correction is an understandable reaction to the changing environment and has revealed some interesting opportunities for investors with the nerve to deny their instincts to remain with the crowd on the sidelines.
The volatility is likely to continue, but could provide the foundations for building future profit.
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