Insights into key market performance and economic trends from Dan Kemp, Morningstar’s global chief research and investment officer.
In a busy week ahead for economic data, the focus of investors is likely to be on inflation data with the latest reading on producer prices on Tuesday and the Consumer Price Index (CPI) on Wednesday. Annual core CPI (which excludes volatile food and energy prices) is expected to fall from 3.8% to 3.6%. A higher number would challenge the dominant narrative among investors that inflation is falling (albeit at a slower rate than most hoped) and could lead to volatility in asset prices. However, it is important to remember that a single economic data point is of little use when estimating the returns of an asset class and therefore more likely to be a snare than an opportunity for investors.
Investor Sentiment to the Fore
Last week was light on data and but heavy on comment by central bank officials the Morningstar US Market index rose 1.85% and bond yields fell as investors were reassured about the path of future interest rates. This provides us with a great example of importance of investor sentiment on asset prices over short time periods. Separating these changes in sentiment from adjustments to the fundamental attractiveness of an asset is one of the key challenges of investing, as the former can trigger our natural behavioral biases and encourage us to make poor investing decisions.
The influence of sentiment can be when breaking down global equity markets into their constituent components. During the first quarter of the year, 50% of the returns in US equities, came from positive sentiment, as expressed by a rise in the price/earnings ratio, rather than the fundamental returns of the businesses that comprise the index (profit margins, sales and the return of capital to shareholders).
While sentiment may continue to improve, driving stock prices higher, it is important that investors recognise that the sentiment component of a portfolio’s value can disappear if investors become gloomier in their prognosis. However, this is not a reason to change investment strategy as this value is likely to be rebuilt in the future providing the price of the asset does not significantly exceed its fair value.
To dig further into this data of this type, you can download our quarterly Markets Observer here or find it on Direct Compass.
Investing in An Election Year
A key driver of sentiment this year is likely to be the general election. Research by Morningstar Wealth illustrates the danger of allowing political views to influence investing decisions and the importance of remaining focused on the long term, ignoring all of the politically driven forecasts that will become a bigger part of the news cycle as the year progresses.
