Global share markers have been hammered over the final quarter of 2018 with the benchmark US S&P/ 500 index down nearly 20% since its high and the tech-heavy NASDAQ index down more than 23% from its record high at the end of August.
In Australia the benchmark S&P/ ASX200 (ASX: XJO) index is down around 9% from highs set at the end August.
Don't be fooled by the relative outperformance of the local share market recently though, as over a five-year period for example it's only 4% higher, compared to gains around 34% for the S&P/ 500 index.
However, the big share price falls everywhere mean now may be the perfect time to pick up some shares in quality companies at steep discounts to recent prices. So let's consider some reasons why shares now be cheap, rather than value traps.
Earnings – this comes first as profits drive share prices higher or lower over the short and long term regardless of sentiment.
Earnings growth was generally very strong for US companies in 2018 thanks to a backdrop of strong economic growth, tax cuts, and share buybacks. The same companies are set to hand in their quarterly report cards in early February 2019 with plenty to suggest investors could be looking at more strong growth for the quarter ending December 31, 2018.
Australian companies will also hand in their half-year reports in February 2019, with some in the tech or healthcare space for example still delivering double-digit profit growth on a consistent basis. Take a look at CSL Limited (ASX: CSL) or Altium Limited (ASX: ALU) as two businesses that have been sold-off recently. CSL I'd rate as a buy today.
Valuation – In terms of problems in the global economy there have been a lot of symptoms recently (share market falls, flatting yield curve), but no one is sure of a serious illness.
Therefore, the big falls in U.S. markets and Australian tech shares may have been more to do with over-valuation than anything else. So today's heavily discounted valuations may present an opportunity when sentiment is weakest.
Yield curve – nothing intimidates equity investors more than the bond markets. As we have seen with the yield curve's recent inversion that scared the living daylights out of sell now, worry later, equity investors.
The yield curve represents future expectations and changes daily, with short-term borrowing rates rising as the US Fed lifts cash rates. Will growth turn negative for two consecutive quarters in the US in 2019 or 2020 to mark a recession? Possibly, but with wage growth strong and unemployment low, not even bond managers knows the future or the Fed's next move for certain.
Selling equities in August 2018 would have been a great move if you knew the yield curve was going to invert, but selling now in anticipation of a recession may be a mistake as it's potential is already priced in. The mistake will be even worse if longer-dated yields rebound in 2019 as optimism returns to the global economy.
Sentiment – over the short-term sentiment drives share prices higher or lower and with political instability in the US, a trade war with China, Brexit, Italian debt problems, and falling house prices in Australia, sentiment is currently poor.
In fact much of the selling on low volumes is in anticipation of a "crash". However, this is a mistake as all of the above factors and everything else every market participant collectively knows about the future is already priced into stocks. Next month's stock prices are unknown in the same way as next month's news.
Yields – for Australian investors in good quality stocks yields are higher, which is a good thing, as you can buy more cash flow for less capital. As long as you buy the right companies. One business now offering an even bigger yield I like for example is Magellan Financial Group Ltd (ASX: MFG).
However, be careful to avoid dividend traps as high yields are often a sign the market expects dividend cuts. And the market is rarely wrong. As such I'd avoid the likes of Telstra Corporation Ltd (ASX: TLS) or the residential-property leveraged banks like Westpac Banking Corp (ASX: WBC).
