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Current market may be overestimating the good news while underestimating US equities risks

29 November 2021 PSG Wealth Chief Investment Officer, Adriaan Pask

South Africa’s sovereign downgrade to “junk status” in 2020 set off a chain reaction among the investment community, which was exacerbated by the COVID-19 pandemic. The prevailing sentiment was that local investment carried with it a substantial risk – an opinion that was priced in by the market.

With the breaking of that news, yields went from 8.5% to 9% and even in some cases to almost 12%. Shortly after, the markets settled down following the downgrade – an indicator that risk can sometimes be overestimated when sentiment is poor. For strategic investors, mispricing of this kind marks a promising (and potentially lucrative) opportunity.

This is the opinion of PSG Wealth Chief Investment Officer, Adriaan Pask, who points to an example that impacted the US market, which went through a tapering exercise in 2013. At this point, the market saw bond yields spike from 2% to 3%. However, 2014 would see those yields falling once again from 3% to 2%, marking a significant opportunity and an indication that due to overarching pressure, risk was overestimated.

Reciprocally, the inverse may be true of the current state of US equities, where market sentiment is overwhelmingly positive. Wall Street equities, for example, recently completed their longest streak of record closing highs since the late 1990s. Stocks and shares have therefore been priced accordingly.

However, in Pask’s opinion: “There's so much good news now, it seems like the market is completely overestimating this aspect and underestimating the risks. That's something that strategic investment professionals should look out for in the coming months.”

He explains, “What these pricing mechanisms point to, is that markets are highly susceptible to the opinions of individual analysts and fund managers who trade stocks and shares, which often leaves room for error and mispricing. The influence that sentiment has on the market amidst (and often despite) a myriad of other contributing factors including historical data and geopolitical events, cannot be underestimated. Mispricing, however, is a phenomenon that opportunistic investors can exploit to their benefit.”

Pask adds that forward-thinking investment professionals need to be able to identify the areas where other investors are potentially making mistakes and then use those mispricing opportunities to generate investment answers for their clients.

On this point, Park elaborates: “I think a useful rule of thumb is when markets are on the up and opportunities are often overestimated and risks underestimated, all the focus is on the good news. Contrary to that, when markets are under pressure, what we often see is that the risks are overestimated and the opportunities underestimated – which then creates some opportunities as well.”

For Pask, being able to identify these gaps in the market comes down to experience, which should arguably be one of the most important traits to look for when choosing an investment partner like a financial planner, wealth planner or investment manager.

Ultimately, even in markets dominated by technical and sentiment analysis, there is often a case to be made for the importance of experience. Seasoned advisers who have paid close attention to pricing mechanisms over a number of years and have dealt with the way that markets overreact to news, will have invaluable insights to share and strategies to develop that are driven by a holistic outlook.

For advisers, Park has the following advice: “Obviously diversify the portfolio for that unexpected event – whatever it might be. And then also have realistic expectations of what markets do over the short and the long-term. If you've got realistic expectations that a decent market correction, or a serious market event, is something that you're going to see along your investment journey, then I think that will really help in making sure that you don't make mistakes when these events occur.”

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