Rudi's View | 10:00 AM
By Rudi Filapek-Vandyck, Editor
Can we trust our fellow-investors?
Many years ago, a local strategy update by UBS made that question the central premise of a share market assessment that, ultimately, resulted in the conclusion it was probably best to pull some profits to the sideline and prepare for more volatile times ahead.
With share markets near all-time record highs, and the forward-looking PE multiple for the ASX200 above 18x, a level seldom witnessed without a sell-off beckoning, while there are plenty of 'risks' lingering, it's probably an apposite question to ask ourselves.
In last week's edition, I explained how the resilience of markets and the steady rise in valuations this year can be explained by investors' forward-looking focus. It may still be the case that, come 2025, this year's confidence proves accurate and justified.
But markets are not 100% rational; they are made and moved by people.
The Nasdaq index year to date is up in excess of 22%, with the S&P500 not far behind and the Dow Jones (DJIA) up by 13.73%, ex dividends. In Australia, the local market including dividends has returned nearly 10% year-to-date. Many gains from individual equities have been multiple times larger.
Can we trust our fellow-investors to stay "confident" and "relaxed" when the proverbial hits the fan?
It used to be general market wisdom that 'bad things tend to happen when markets trade on elevated valuations', but it has been a while since I heard anyone referencing it.
Markets have been strong, for sure, and overall volatility has remained low. Outside of Australian banks, and the occasional hyped-up growth story, there hasn't been too much around to genuinely worry markets.
For every profit warning that came out of nowhere, like Web Travel Group's ((WEB)) on Monday, there are equally as many solid business stories around that offer lots of promise and upside. Appeased by central bank rate cuts, and the promise of a brave new world on the back of megatrends Gen.Ai, GLP-1s and others, markets have firmly kept their focus on the positives.
Let's assume, for our own general risk-assessment, that bad news does tend to happen when markets only take into account the positives from the future on the assumption that no interruptions will occur, what risks are there we can identify?
Key Risk Number One
I suspect the immediate threat to current tranquility resides within the Israeli war with Iran and its neighbouring proxies.
Thus far, US president Biden has managed to prevent direct Israeli attacks on Iranian oil infrastructure, but general sentiment inside the US capital is that Biden's influence seems to be waning.
A fresh update from analysts at RBC Capital concludes: "There is an expectation in Washington that Israel will indeed launch a major strike that will cause substantial damage".
If correct, I worry Iran will equally retaliate with force. Markets will have to price in the risk of broad escalation in the region.
RBC Capital: "While administration officials hope that Iran will opt for a more calibrated counteraction to enable an offramp, the Iranian leadership is not expected to sit on its hands and do nothing.
"While some officials at UNGA indicated that the newly elected reformist President Pezeshkian was exercising a restraining influence on Supreme Leader Khamenei, the Iranian Revolutionary Guard apparently drove the decision to launch the missile strike and may hold considerable sway in the coming weeks.
"We also continue to highlight that the US election calendar may also influence Netanyahu's war calculations, with American support potentially at its peak before the polls close on November 5.
"We believe that there is a corner of the market that will hit the sell button on any sign that Israel is taking a pass on hitting Iranian oil facilities, and wind the clock back by several weeks.
"We would caution that we may be entering the most dangerous retaliatory spiral of this one-year war, and the risk of a full regional confrontation will remain appreciably high, even if Kharg Island is spared in the next Israeli strike.
"Moreover, based on our conversations here, Israel apparently has a serious contingency plan on the books to inflict a devastating blow on Iran's oil industry."
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