What to expect from the stock market?
Montgomery Investment Management
23 June 2022
In this week's video insight Roger discusses what could be next for the stock market. We already know that P/E ratios have compressed considerably, and taken into account all of the increase in bond rates. What they haven't done, of course, is priced a very significant recession, nor have they priced the possibility of a financial crisis of any description. But what happens if rates stop rising, and if economies don't go into a recession, and we don't get a financial crisis?
Hi, I'm Roger Montgomery, and welcome to this week's video insight. Well, bearishness pervades almost every corner of the market at the moment. In my travels, in talking to brokers, other fund managers and economists, I don't find many people who are very bullish at all. In fact, most of them expect another leg lower in the stock market. Of course, for me, that starts to become optimistic because if everyone's already bearish, there's not many others left to become bearish. Those who are bearish have already sold, there's not many people left to sell, and so it may be that prices are now on the cusp of a bounce.
But rather than speculating about that, let's just think logically about what could happen next. We already know that P/E ratios have compressed considerably, and taken into account all of the increase in bond rates. What they haven't done, of course, is priced a very significant recession, nor have they priced the possibility of a financial crisis of any description. We'll address those two subjects in a moment.
But if rates stop rising, and if economies don't go into a recession, and we don't get a financial crisis, then there's a very real possibility that the indiscriminate selling that we've witnessed recently becomes something more discerning and buyers return to the market to look for downtrodden, high-quality growth companies. That's one possibility. The other possibility, of course, is that the deterioration in consumer confidence, such as what we're seeing in New Zealand at the moment, after five interest rate increases there, and a similar event here in Australia is a consequence of rising prices as well as declining property prices, could result in less funding being available to venture capital and private equity companies. If that happened, then that would mean a lot of people who are currently employed, thanks to the altruism of shareholders, could become unemployed.
There's also a more significant possibility that those people employed in construction, and remember construction is the third largest employer in Australia, there's a very distinct possibility that those people have less work on. And that's because falling house prices and rising costs make people defer or delay any alterations and additions that they might have conducted on their properties. And so it's significant to think about, or important, rather, to think about the possibility that we get rising unemployment from those sectors of the economy that are being funded by altruistic shareholders, those who have previously had very cheap money or free money to access to be able to fund startups, venture capital and private equity. Or there's a possibility that we see unemployment rising amongst those people in the construction sector.
Now, thinking through the transmission mechanism of that, if that happened, then we would get a much more significant decline in economic growth, and then the possibility of a recession goes up. But as I said earlier, in the absence of a recession and in the absence of a financial crisis, and I don't think any of those two things are very likely right now, then we're in a situation where we've had indiscriminate selling, pushing P/E ratios very, very low, and that of course means the possibility of better returns in the future. So if indiscriminate selling gives way to more discerning buying, we'll get an expansion of P/Es again, and that will increase the return available, that would normally be available, rather, just from the earnings growth.
So my suggestion now is to start dipping your toe back in. It's not a recommendation of course, but it's something that I'm doing myself. I don't know whether prices will rise from here or continue lower. It could be that the rest of my peers in the market are absolutely correct and we get another leg down. I just don't know. But I do know that there are some mouthwatering opportunities already appearing, and rather than try and predict what prices are going to do next, I'd rather start filling my portfolio with wonderful businesses at rational prices. That's all I have time for today. I look forward to speaking to you again next week, and in the meantime, please continue to follow us on Facebook and Twitter.
Speaker: Roger Montgomery, Chairman and Chief Investment Officer
Funds operated by this manager:
Montgomery (Private) Fund, Montgomery Small Companies Fund, The Montgomery Fund