After a wild year, what can investors expect in 2020-21?
Last financial year - 2019-20 - was the most volatile financial year for the share market in more than a decade. The S&P/ASX 200 index rose to an all-time high, before plunging to a seven year low. The recovery from the March 2020 low was unevenly distributed, with some stock and sectors languishing while others hit new heights. What does the new financial year hold for investors?
Any assessment of the prospects for the next 12 months starts with an examination of where the market is right now. In essence, investors face two contradictory market narratives.
The first is for a v-shaped economic recovery, fuelled by central bank and government support, and dependent on the lifting of virus containment measures. In this scenario the share market rally continues. This positive perception lifted the share market off the March low. There is evidence suggesting this view is primarily held by individual investors.
The other market story is much more sombre. This is a tale of a second leg down for shares. The 39% drop in the share market index convinced many institutional investors that the market disruption is more of a crash than a correction.
The professionals cite the clear evidence of economic destruction, and point out that typically it takes quarters or years to recover from a crash, not weeks or months.
Who's right? Nobody knows the future, so no-one can say. At the moment bragging rights belong to the first group - the retail investors that drove local and overseas share markets higher in the last quarter of the financial year. But because share markets go up the stairs and come down in the lift, the situation could change rapidly.
It's not clear what will resolve these conflicting market views. Even if a cure for the Covid-19 virus is found, a return to pre-crisis activity is not a surety. As an example, more than 20 million US citizens need a job. Placing all these workers will take time.
On the other hand, the coming company reporting season could provide hard evidence of hits to corporate bottom lines. However if investors choose to "look through" the data, to a potentially better time ahead, the share market could rise.
One implication for investors is that the stock market will be driven by sentiment. This may mean not just higher market volatility, but also volatility of volatility.
Periods of wild swings in share prices give way to relative calm, before the gyrations start again. The huge take up of shares by individual investors after the viral outbreak means there are many with no experience of falling prices. If a rout begins, the level of panic could exceed previous sell downs.
Another product of the higher uncertainty is that investment tools that served well in the previous 10 years may be less reliable. Stock valuations, price to earnings ratios and dividend yields all incorporate forward estimates.
In this market environment these are suspect, and a less useful guide. Investors could choose to increase the number of market measures they use to assess shares, reducing reliance on any one indicator and the possibility the future proves it horribly wrong.
Perhaps the best lesson to take into the new financial year is that market disruptions happen, and that risk management should be a part of every investment plan.
Diversification is a powerful risk management tool that all investors can use.
Diversifying across and within asset classes, and looking for investment opportunities that perform differently under a given set of circumstances, can reduce overall portfolio risk. Investors must decide for themselves whether a higher risk and reward approach is preferable to a good night's sleep.
The information presented in this article is general in nature and should not be considered personal or financial advice. Seek independent advice and consider the relevant Terms and Conditions at cmcmarkets.com.au when deciding whether to invest in CMC Markets products. CMC Markets Asia Pacific Pty Ltd (ABN 11 100058 213 AFSL No. 238054)