Opinion | Garry Crole | CEO & Managing Director | Sequoia Financial Group (ASX:SEQ)

I’ll never lose that passion for my first gig in this industry, going all the way back to 1984 when I was a fresh-faced 21-year-old advisor with Colonial Mutual.

In these monthly compass chats – think of them as a replacement for those Monday emails you used to get from me – I’m aiming to share a key idea on running your practice, as well as giving you my thoughts on the markets.

And when it comes to markets, well, I’m a tad nervous. These days, it’s harder than ever to figure out if we’re swimming in a sea of greed, where asset prices are wildly overvalued, or if fear is creating lower asset prices, offering a chance to be brave.

I want to look at four key areas of the market where I think answering that question has become bloody difficult. Especially for the 85% of Aussies who don’t have an advisor or the financial literacy to navigate this on their own – I worry about them.

The rise and rise (and volatility) of crypto as an investment vehicle is almost unbelievable. As advisors, we provide guidance and peace of mind, and it’s more important than ever to keep in regular contact, reinforcing those long-term strategies that suit each client’s risk profile. That’s how you keep satisfaction levels high.

Over the next year or two, I reckon we’re in for some wild intraday and intra-month swings in asset prices. You’ll need a sage and well-planned asset allocation to make sure people don’t sell at the bottom and chase shiny objects at the top.

You may remember that I shared my thoughts on the value of CBA and Nvidia multiples last month, and the distortions of other multiples. So let me delve into some key areas I wish to discuss:

Trump’s “America First” Policy

The first elephant in the room is the impact of a Trump election victory and his “America First” policy. Now, his initial policies and tariffs during his first term certainly created market volatility, but markets were also very strong.

History shows that tariffs typically disrupt global trade flows, increasing costs for businesses and consumers, which is, in turn, inflationary.

The uncertainty around trade wars and protectionist policies can lead to stock market sell-offs, particularly in sectors heavily reliant on international trade like technology, automobiles, and manufacturing. We’ve seen some of that recently. Trump’s election victory led to a market rally, but I reckon that was more to do with tax cuts, deregulation, and a general pro-business stance.

The threat of trade wars with the likes of China has created headwinds for multinational companies with significant exposure to international markets.

Remember that the recent drop in interest rates both in the US and Australia won’t continue if inflation concerns and geopolitical tensions with China and Russia play out as many market experts expect.

Our local market is likely to be negatively impacted as tariffs hurt us. The US itself may benefit from a resilient home consumer sector and strong economic fundamentals.

My summary on Trump at this point in time is he will be good for US markets over the medium term, but we will see wild swings in volatility.

Overvalued US Stocks

As I said last month, I’m negative on companies whose PE has escalated to a level never seen before. I’d be nervous about buying in the US the likes of Apple, Nvidia and the big 4 or 5 that make up the top end of the S&P 500. Instead, I prefer the mid-caps and fund managers that invest outside of the index and are value managers.

We continue to see PE (Price-to-Earnings) ratios for many US companies at or near record highs.

High PE ratios reflect investor optimism of continued earnings growth or that stocks are expensive relative to the earnings companies are generating. I reckon the latter is the case in many of the biggest US companies at present, even though this is less so today than it was before Christmas.

Many market experts believe a correction or “valuation reset” is inevitable, especially if earnings growth doesn’t keep pace with these elevated multiples.

If interest rates were to cease falling on inflationary fears associated with tariffs, be fearful.

The ETF Bubble

A major factor in my opinion as to why so many at the top end of the indexes have rallied so hard is the evolution of Exchange-Traded Funds (ETFs) and passive index investing in recent years.

ETFs have led to significant capital inflows into broad market indices like the S&P 500. This has further fuelled the rise in stock prices, particularly in the most heavily weighted stocks (like the large tech giants: Apple, Microsoft, Nvidia).

The anti-fee argument and low-cost dominance of ETFs and index investing have the potential to exacerbate valuation bubbles.

Since ETFs track indices, money flows into them automatically, regardless of the underlying stock valuations. This creates a feedback loop where stocks that are part of the index rise in price due to inflows, pushing valuations higher.

The boom of the meme coin TRUMP was a classic case of this. The TRUMP coin on his election hit $80. Today, it’s $12.00, and billions of monies lost, mostly a result of outflows surpassing inflows, which is a risk many do not regard as certain as I do.

This decoupling stock prices from the underlying fundamentals contributes to an escalation of valuations. If this trend reverses (e.g., through outflows from ETFs during a market correction), it could lead to a sharp revaluation and reset of market prices.

Super Fund Influence

The last of the four concerns I have regarding risk to asset prices is the continued impact of the large Industry Super Funds market influence in Australia.

These funds typically do have long-term investment horizons, but they still need to manage risk and liquidity.

The retirement of the Baby Boomer generation poses significant risks. As boomers like me move from accumulating wealth to drawing down on their retirement savings, the flow of funds into equity markets could slow. Additionally, as FUA falls as flow comes out of such pooled investments, the large-scale selling could impact market liquidity and valuations, particularly for those companies trading at PEs well above normal.

In addition, if there were a significant shift in pension fund allocations or redemption pressures, it will lead to liquidity issues in the market.

During a market correction, if funds need to liquidate positions to meet withdrawals, this could exacerbate a downturn. The size and interconnectedness of these funds mean that a significant sell-off by them could lead to a self-fulfilling prophecy of a liquidity crunch.

Experts often cite the risk of a crash if a combination of factors converges:

  • Overvaluation of assets.
  • An economic shock (e.g., a recession, geopolitical event).
  • A sudden change in interest rate policy (e.g., the Federal Reserve raising rates aggressively).
  • Large institutional selling from superannuation funds as Baby Boomers retire and liquidate their holdings.

If liquidity is tested, the risk of a market correction increases. In extreme cases, this could lead to a significant crash.

Final Thoughts

The current market outlook is a mixture of optimism and caution.

While the US equity market has been buoyed by strong consumer spending, the evolution of ETFs, and institutional investment, the high valuation levels, potential interest rate hikes, geopolitical risks, and shifting demographic trends all pose significant risks.

The growing dominance of passive investing and large institutional funds introduces additional market distortions, which could amplify the risk of a market correction or crash if liquidity is tested.

My suggestion for advisors is to ensure each client’s asset allocation matches their risk profile. Be careful about simply buying the index and consider using fund managers that are not passive but able to buy value. Keep clients’ portfolios cash positions ample to fund their income needs so they are not placed in a position to have to sell assets to fund income when markets take a short-term fall.

Lonsec and SQM research categorizes the difference between each manager’s style. Over the next 2-5 years I would definitely be ensuring allocation of clients’ international and local equity portfolios is not weighted the same as everyone else. Select the most competent managers based on value, liquidity, the sustainability of earnings growth, and potential shifts in investor sentiment from risk-on to risk-off.

I hope I have not made my view too complex. If you are doing your next review and the client asks an opinion on markets, use it with your clients to gauge their current view. I’ll catch you next month.


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