Financial crises and recessions — should investors worry about them?

Pic By BLOOMBERG

Many investors have started to worry about the next potential financial crisis as we step into the 10th year since the global financial crisis of 2007/08.

Pessimistic investors, who thought the amplitude of the current market cycle was diminishing, were proved spectacularly wrong as both the global equities and fixed income markets are still holding up well.

Thoughts that we are nearing the end of a bull run are concerning some investors. Hence, in this article, we will discuss how investors should position themselves for the future uncertainty.

Investors often have the misperception that a financial crisis is similar to a recession, as some past recessions were related to past financial crises.

One should take note that a recession and a financial crisis is not always the same.

Theoretically, a recession is defined as two consecutive quarters of declining gross domestic product (GDP) in a particular country.

A recession is marked by a deterioration in economic activity, decline in consumer and business confidence, rising unemployment, fall in consumer spending, industrial production and capital spending by corporates, as well as falling bond yields.

A financial crisis is defined as a situation where the prices of financial assets plunge, mainly due to oversupply of money or irrational exuberance of investors.

It is marked by too much money or too many investors chasing too few assets, resulting in asset prices being pushed to levels their valuations could not justify.

The past 30 years have seen financial crises such as the stock market crash of 1987 (known as “Black Monday” where the Dow Jones Index lost more than 22% in a single trading day), the Asian financial crisis of 1997 and the global financial crisis of 2007/08 (subprime crisis).

If a financial crisis is not well managed, it might sub-sequently lead to an economic recession.

Although the US equity market is currently trading near historic highs, the economic fundamentals remain well supported by several factors — including ameliorating earnings and various positive macroeconomic data.

US economic activity posted an encouraging rate 2.6% (annualised) growth rate in the second-quarter (2Q).

Leading indicators like the Purchasing Managers’ Index and Consumer Confidence Index are trending at healthy levels.

Within the Asia ex-Japan region, positive earnings revisions year-to-date and improving corporate earnings will be a key driver of the markets ahead.

GDP growth for Asia ex-Japan continues to accelerate in the 2Q — driven by strong export growth — while foreign reserves remain at healthy levels (current account balances are in good shape) on the back of low political un- certainty, encouraging corporate earnings and decent macroeconomic data.

On the local front, Malaysia’s economic activity posted a two-year high growth rate of 5.8% in the 2Q, leading the International Monetary Fund and World Bank to upgrade their forecast for the 2017 GDP growth rate to 4.8% and 4.9% respectively.

The improving macro outlook suggests the local economy is highly unlikely to enter a recession.

At Fundsupermart, we do not encourage investors to time the market. Instead, we strongly emphasise on the time one stays invested in the market.

Reason being, for investors who stayed invested in the market for the past 10 years, they would have earned an impressive return of 107% and 112% from the FTSE Bursa Malaysia KLCI Index and MSCI World Index.

A market timing strategy offers significantly less returns. For example, if we assume investors missed out on the 10 days of best returns within the 10-year period (due to poor market timing), their 10-year return would be reduced significantly to only 51% and 16%.

For investors who missed out 30 days of the best returns over the past 10 years, their return would be -2% and -29%.

If one doesn’t have a crystal ball, it is wise to stay invested in the market as it can be very costly to time the market.

It is extremely tough to predict future events with any accuracy and hence, we advocate a portfolio approach with disciplined rebalancing.

At this juncture, we continue to ‘Overweight’ equities vis-à-vis bonds after the previous reduction in equity ‘Overweight’ by 5% (from 10% previously, to 5% currently).

As valuation of developed markets is getting expensive, we retain an ‘Underweight’ position in developed market equities.

We continue to prefer the faster growing and yet, more attractively valued, regions of Asia ex-Japan and other emerging markets.

Both continue to trade at a discount to our estimated fair price-earnings ratios, indicating they continue to remain undervalued despite having turned in a sterling performance in the first-half of this year.