Despite warnings of a potential crash due to inflated AI share prices, markets around the world continue to hit records.
Photo: 123RF
It would be good for markets to go through a small correction to avoid a bigger explosion, one fund manager says.
Despite warnings of a potential crash due to inflated AI share prices, markets around the world continue to hit records.
Murray Harris, head of KiwiSaver at Milford Asset Management, said it was a worry.
“The market is being buoyed by continuing prospects for lower interest rates… and companies that are doing well.
“There’s not a lot of reason for people to be thinking ‘oh this is going to end’ other than the professional investors like ourselves going ‘well this can’t last forever’.”
He said as prices pushed up, it would be useful to have occasional 10 to 15 percent falls.
“It would be healthy to have a bit of a pullback on markets and think of it like a pressure cooker. If it keeps building and building and building it’ll blow but if it lets off a little bit of steam, then we get a 10 percent or 15 percent pull back then the market can move higher again.”
But Rupert Carlyon, founder of Koura Wealth, said when adjusted for inflation the increases recorded did not look so dramatic.
“Over the last five or six years inflation has been about 35 percent so even a market that is up 35 percent today is basically where it was five years ago.”
He said even the big companies that seemed highly valued were strong on growth and return-on-equity measures. “I personally do not believe there has ever been a set of companies as strong in delivering the growth numbers that currently we have.”
He said there had been many warnings over the past five years that a market rally was unsustainable.
“We saw it when interest rates started going up, we saw it with the tech bubble kind of starting to burst a bit… every time it’s been proven wrong.”
What can investors do?
Harris said although the market felt “frothy” it was not a reason not to be invested.
“As an active manager, we can take protection through derivatives and we can move cash around and we’re doing that, and can look for opportunities outside the really highly inflated industries and assets. It kind of feels like it can’t keep going on forever, and it won’t.”
Some investors have moved money into assets such as gold. Harris said when he was in Sydney last week there was a line around the corner for a bullion dealer.
“That to me is a sign of a bubble, but it doesn’t mean the price can’t continue to go up… it does well when there is high inflation and a bit of geopolitical uncertainty because people go ‘well I have this physical thing and I can put it under my bed’, but at the end of the day it doesn’t generate any dividends or revenue or profits or income. You’re totally reliant on the person you sell it to being willing to pay more for it than you paid.”
He said people who were investing for the long term should look through the market movements.
“If you’ve got a 10-year view, we’ll see some sort of pullback at some point but if your goal hasn’t changed, your risk profile’s the same, then you stick with it.”
He said the market buoyancy seemed to be prompting a large number of transfers between KiwiSaver providers. “I think, with the confidence that people are getting from markets going up and their values going up and their balances getting bigger, they’re thinking ‘maybe I should do some more research’.”
Falling interest rates had also prompted people to move from term deposits to managed funds, he said.
Harris said he had seen a lot of money flow out of bank deposit into retail unit trust funds.
“We’ve seen record levels of flows into those from people that have taken money out of term deposits. That’s a sign that markets are at a toppy level.”
He said people need to understand the additional risk that came with investing in funds.
“We explain this to everyone who is investing with uis, they could go down. You could be buying at a high point in the market. This is not going go be like your term deposit, that’s just going to keep your capital and give you a return.”
Carlyon said investors should try to ignore the noise. “Over the last five or six years there’s been a huge amount of negativity in the press. There is a lot of people that don’t like and don’t want to believe the current market rally… what we’ve seen is the only smart way to be invested is to stay invested.”
Do passive investments exacerbate the market movements?
Mike Taylor, founder of Pie Funds, said there was the potential for exchange-traded funds to exacerbate any potential fall.
There has been a big increase in passively invested funds in recent years, which aim to replicate a market index rather than outperforming.
“The interaction between an ETF and the underlying market can work a bit like the futures market and the cash market,” Taylor said.
“When volatility rises, usually to the downside, outflows from ETFs then lead to lower underlying stock prices, which then lead to more outflows.
“If we had a period when prices fall rapidly this could be problematic, particularly when you consider leveraged ETFs.”
Harris said an index fund had no option but to buy the expensive AI stocks.
“The weighting of those companies goes up every day in the index and they’ve got to buy more. But similarly they’ll have to sell more when the markets drop.”
He agreed leveraged ETFs could have an even bigger impact.
“When the market’s gone up it has to buy four or five times the exposure of the market… If the price is down it has to sell four or five times the value of the stock it’s holding. That could have some quite big moves.”
Dean Anderson, founder of Kernel, said the question was not whether money was actively or passively managed but whether there was new money coming into or out of equities.
“If it is net new buying demand into equities, that say previously has been in term deposits or cash, whether that goes into direct stocks, active, or passive funds – it is ultimately net buying power for equities which would support higher prices. The same is true in reverse.
“The active manager may argue they don’t have to buy or sell stocks when cash goes into or out of the fund – but in practice that isn’t the case. If they had a lot of withdrawals, they will be a seller, equally if they get a lot of applications they will have to buy as they risk having their performance lag if they sit on too much cash for too long.”
Carlyon said retail investors were also more likely to follow trends. They have become a much more dominant force in recent years.
“When I started my career a market move of 1 percent or 1.5 percent in a day was kind of unusual, whereas we’ve seen two or three days this week which have been over that number.”
Sign up for Money with Susan Edmunds, a weekly newsletter covering all the things that affect how we make, spend and invest money.