Investors should consider recent events in global markets through the lens of price versus fundamental change, says Morningstar's Clint Abraham.

To help explain the pronounced market reaction and "look through" the noise, Morningstar Investment Management Australia's portfolio specialist, Clint Abraham, notes the irony of the US situation.

Pointing to the falls across US stocks listed on the Dow Jones, S&P 500 and tech-focused Nasdaq, he says: "ironically, if market headlines are to be believed, this was in reaction to stronger employment figures released last Friday, where the market is now thought to be concerned that the jobs figures are too good and will force the central bank to raise interest rates faster and higher than predicted".

"Following the swift change in sentiment, global markets have fallen sharply, with European
and Asian markets deteriorating amid the volatility spike.

"Making headlines are the short-term moves in Japanese equities, falling by nearly 5 per cent from peak to trough, while the FTSE is down almost 6 per cent, Europe down 5 per cent, emerging markets by approximately 4 per cent, in local currency terms, and the Australian market down more than 3 per cent," Abraham says.

Exhibit 1 The U.S. equity decline in perspective

Source: Morningstar Investment Management calculation, Morningstar Direct to 05/02/2018

Referring to the above chart, he notes there have been "very few periods of genuine market stress over the last couple of years and, secondly, in the context of history, the magnitude of losses is less significant".

"Bond markets have also experienced heightened volatility, with interest rates on 10-year

Treasury bonds rising rather sharply on Friday (to 2.84 per cent), only to reverse on Monday as

investors rushed to take advantage of the lower price and higher yield.

"This phenomenon was extended globally--and among currencies--as investors attempt to make sense of the ramifications of strong wage growth and the potential for higher inflation," he says.

How investors should interpret this

"One must remember that the jobs figures showed the highest wage growth in eight years, not the weakest. So, it seems rather ironic that it was the sole catalyst for investor panic, as it is something the market had desired for so long.

He highlights this as a clear example of the difficulty of applying rational processes to explain sentimental shifts, "and reinforces the need to focus on valuations".

"Under this framework, it is important to look through why the investor reaction was so pronounced, which is best considered under the lens of price versus fundamental change.

"Is the market reaction more to do with the nervousness extending from the stellar bull market of 2009-2017? Or can we expect a material impact to corporate profitability?

"While we are not in the business of forecasting short-term sentiment, we can

look at current prices, where US equities have been considered as overvalued for some

time now.

"We can also apply thought to the evidence, which overwhelming shows that

prices are more likely to fall back in line with fundamentals, especially when prices run well

ahead of intrinsic value," Abraham says.

In the context or recent events, he also points to the wisdom in the following quotes from some of the best investment minds of recent generations:

The ability to focus attention on important things is a defining characteristic of intelligence.

Robert Shiller

Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Warren Buffett

Bull markets are born in pessimism, grow on scepticism, mature on optimism and die on euphoria.

Sir John Templeton

What action Morningstar is taking

Morningstar's Abraham emphasises the need to acknowledge that periods of market turbulence can be especially dangerous for investors, because they can elicit responses based on emotion rather than rational analysis.

"The Morningstar Investment Management team will be spending the next days, weeks and
months watching the developments closely in this context.

"However, we will be focusing on the same principles as we would any other period; assessing the value of each asset class, digging into the fundamental drivers of returns and challenging the fear/greed corollaries that we are all behaviourally exposed to," he says.

He highlights that the elevated levels of cash held in Morningstar's portfolios--in response to stretched valuations--should serve a two-fold role in buffering against current volatility and providing "ammunition should any exemplary opportunities present themselves".

"We appreciate that many are nervous about the current market conditions, yet it is important that we stick to our plan and focus intently on the objective at hand.

"We similarly advocate that one remembers the tenets of great investing; to be thoughtful, be long-term focused and be willing to challenge our own behavioural biases," Abraham says.

"While this is nowhere near as exciting as making quickfire trading decisions, it reflects our
observation of how the most successful investors operate."

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Glenn Freeman is a senior editor at Morningstar.

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