Bob Homan: Fairy tales do exist
This column was originally written in Dutch. This is an English translation.
By Bob Homan, Global Chief Investment Officer, ING Global Investment Centre
Booms and busts seem to be the natural law of financial markets. But every now and then, even on the stock market, the supernatural seems possible.
In the late 1990s, I analysed the stock market and came to the conclusion that it was extremely expensive. So expensive, in fact, that I saw little prospect of further price rises for several years to come. I thought at the time: how lovely it would be if the market simply did very little over the coming years. Then corporate profits could, as it were, be reflected in the share prices, whilst investors would still achieve a decent return thanks to dividends.
Dangerous words
But things rarely go that smoothly in financial markets. Things turned out differently at the end of the last century and the start of this one, too. First, valuations were stretched even further, only to crash hard shortly afterwards. I learnt what experienced investors had known for a long time: gradualism in financial markets is usually a fairy tale. It’s boom and bust.
This time, however, things seem to be turning out differently. Yes, I know: dangerous words! But the fairy tale of gradualism actually seems to be becoming reality. The profits of IT companies in particular – which dominate the stock markets – have genuinely grown in line with their share prices in recent years. Whilst the share prices of these companies have risen sharply, their profits have risen even more sharply.
The fairy tale is coming true
Of course, we know that such high profit growth cannot continue indefinitely. Earlier in history, for example around the year 2000, the market seemed to largely ignore this fact. The shock came when it became clear that the hoped-for profits – or their growth – could not be sustained. Share prices halved, or worse. This time, the market seems better prepared for a slowdown in profit growth. For instance, Nvidia’s valuation has more than halved in the space of a few years. Perhaps fairy tales do exist after all.
Of course, that does not mean that volatility is a thing of the past. Here are a few statistics: a correction of more than 5 per cent on the stock markets occurs on average about three times a year. A fall of 10 per cent happens roughly once a year, 15 per cent once every two years and 20 per cent once every three years. Volatility is simply part and parcel of investing, as we have seen once again in recent weeks.
With my renewed belief in fairy tales, I’m not so easily thrown off course by such things anymore.