Morningstar's "Perspectives" series features investment insights from third-party contributors. Here, Mark Wharrier, co-manager of the BlackRock UK Income Fund, explains why keeping your head matters in an environment of volatility.
2016 has started with a bang. With Chinese stocks in freefall, rising geopolitical tensions, lacklustre PMI data and an unseasonably warm Christmas; broad swathes of the market are under pressure. The increased volatility we’ve seen is indicative of the panic felt by the market. In this environment, keeping your head matters. This volatility provides opportunities to buy fundamentally attractive businesses whose share prices have been buffeted by recent events and headlines. Level-headed analysis of the longer-term prospects of a company can determine whether any issues are enduring or temporary and therefore whether there is an attractive investment to be made.
While volatility is extremely uncomfortable, it can bring significant opportunity
Shoot First, Think Later
We are not the first to say it, but it is unquestionably true that markets are increasingly short-term. Average holdings periods have shortened and investors often appear to ‘shoot first and ask questions later’. This short-termism is also evident from analyst research. We looked at one of the large FTSE 100 companies, a company that has been in existence for over 150 years and has weathered its fair share of momentous economic change.
Despite its rich history, there were 38 analysts forecasting the next 12 months’ earnings; that fell to 30 for two years’ earnings, dwindling to just six for three years. This focus on just the next year or two is replicated across the market. Yet a good company needs to ensure that its business can endure for the long-term. Management must take in fundamental shifts in the economic landscape. To us, it seems anomalous to focus solely on what is happening in the short-term.
Temporary or Fundamental?
For us, this is where the opportunity lies. Every company will enjoy good times and endure difficult times, but the market’s first instinct on a rogue quarter’s newsflow is typically to assume the worst, rather than looking at whether the fundamentals of a business remains intact: Have the prospects for the company’s end markets permanently changed? Has the company preserved its market share? Does it still have pricing power and control over its cost base? Or is it a temporary issue – like unseasonable weather?
In our analysis, we do not neglect the short-term, but we also aim to look beyond it, to three or more years out. Is growth going to be higher than the market expects? If so, any short-term weakness in the share price is an opportunity. It can take time for this stronger growth to be reflected in the share price, but we can be patient. We believe this is a fundamentally more disciplined and balanced approach to understanding a company’s long term prospects.
So we reiterate the point that while volatility is extremely uncomfortable, it can bring significant opportunity. Markets can be very irrational in the short-term. As investors, we just need to keep our heads.
Disclaimer
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