CIO says that with market priced to perfection, and bulls and bears pulling it in opposite directions, more turbulence may lie ahead
Advisors should be on red alert moving forward, with markets priced to perfection and central banks turning more hawkish.
September’s volatility shredded investors’ nerves ahead of earnings season with the uncertainty around the U.S. Federal Reserve’s next move causing the bulls and bears to carry out a sentiment tug o’ war. When October came into view, earnings fears were allayed and a consensus formed – confirmed yesterday – that the Fed would unveil a gradual reduction in its asset purchase program. The market reacted with force - higher.
Greg Taylor, CIO at Purpose Investments, told Wealth Professional that almost everyone was surprised at how “violent the reaction was” this month as the market moved upwards and enjoyed consecutive highs. However, this means caution should be the watchword moving forward.
Taylor said: “The question is whether the next few months could be even more volatile as we go back and forth between the bulls and the bears, because we've had a fairly good run. You're going to see some performance chasing, people trying to keep up with the market. But that could get overextended – and that's going to be the big debate going forward.”
He added: “When you see the market this far up on the year, it's kind of priced for perfection. The other thing from a volatility point of view is that we've had this nice backstop over the past year in that the Fed is incredibly market friendly, and every time the market’s gone down, they do something to support it. But it feels that it’s a time of change, and they are starting to remove stimulus and be less focused on the markets going forward. That could add some volatility, and that adds uncertainty for stocks.”
Inflation fears still hang over investors, of course. Is it transitory or is it temporary, and where do you draw the line? As earnings season showed, some companies handled the supply chain issues better than others. Taylor believes the market seems to now be thinking this is just temporary and that we can get through this but if doubts re-emerge, that could be a significant headwind. A lot of people expect everything to now go really well, he added, but if there’s a stumble, when you’re at all-time highs, that could spark volatility.
Taylor also said concerns over the rise of oil prices play into the inflation theme and concern over future earnings. He explained: “There's really no capacity that can be turned on easily this time. We’re also finding companies aren't drilling as much; it's hard to get crews. That means the oil price could be up [in this range] a lot longer than people think – and if oil stays even above $70 for all of next year, that’ll keep prices going up throughout the supply chain. That's where the Fed should be a little more controlled in some of its comments to try and address that, while companies need to get ready for higher costs, which could start to squeeze on margins.”
This potential tightening of profits, along with high multiples and the threat of inflation, suggests advisors and investors must temper return expectations heading into 2022. According to Taylor, investors should be wary of crowded trades and the fact there’s still a lot of complacency in the market.
He added: “We've had two very good years for markets but from an investor's point of view, it's time to recognize we're in the latter stages of the bull market. Usually, when a bull market starts to evolve, it starts to change to different leadership and we've seen that with cyclicals. It could be that people need to start to rotate away from some of the winning trades of the past few years, so it could be time for Canada and the TSX to start to outperform again.”
