Recent turmoil in the markets over the worry that economic growth in China was slowing down caused a crash in the Chinese equity market. This sent global equities into a sharp correction.
What does this mean for our clients? The S&P has dropped 8.5% since May, the FTSE 100 has dropped 13.5% and the Eurofirst 300 is down 12%. With bonds looking risky due to the potential of rising interest rates, how does this affect our current positioning?
Developed world equities are not cheap but are looking far more attractive than in May this year. We expect to see continued returns from the US, UK and Europe albeit with some volatility from pull backs. The G20 feel that there was an overreaction in the US and Europe, and that Global economic growth is improving.
Bonds remain risky, not only with the possible rise in interest rates but with growing signs that liquidity is becoming a problem. Where we can, we are also looking at alternative investments, including hedge funds, but with a wary eye on the risk profile in each case.
Our current positioning
With the core of our investment strategy focused on developed economies, we are minimising our exposure to emerging markets and Asia. These have borne the brunt of the China fall out. The FTSE Emerging Markets and FTSE Asia Pacific ex Japan indices are both down over 20% in the last three months.
Our long term view has not changed. But, in fact, these falls make valuations look even more attractive. In their recent Global Asset Allocation, the Société Générale’s Cross Asset Research team said, “Emerging market equity valuation is becoming attractive.” They go on to point out that, “The valuation of emerging market equities relative to developed market equities is near its 10-year low.”
Now we should explain that with China making about a quarter of the emerging markets’ capitalisation, the falls there were inevitably going to make the overall index look cheaper. But we do genuinely believe that the long term opportunities in emerging markets, and especially those in Asia remain good.
China has $3.65tn of foreign exchange reserves, which could be used to bail out distressed companies and boost the economy. In addition the Chinese could reduce the amount of money commercial banks must hold at the central bank (currently 18.5% of overall deposits). This could then be put to work on the economy. The figure was as low as 6% a few years ago.
So are we in a recession?
Goldman Sachs in their Market Pulse Update take the view that, “In fact, economic recession’s start, on average, about five years after central banks begin increasing interest rates. We therefore believe investors should keep a pro-cyclical mindset.”
We do not believe we are in recession—nor in a bear market. We still expect equities to outperform bonds while acknowledging that it may take a much stronger return of confidence before emerging markets catch up with developed markets.
The Daily Telegraph recently published an article titled “Morgan Stanley issues ‘full house’ buy alert for stocks”. In this, they report that “The US investment bank said that all five of its market-timing signals are now flashing a buy signal as selling-fever reaches capitulation levels.” And that “This is a rare occurrence, typically leading to a V-shaped recovery that delivers a 23pc gain in stock prices over the following 12 months.”
A 23% gain would be most welcome. Can we expect it? Perhaps not in every market but we remain of the view that markets that are oversold as a result of fear offer opportunities to buy at lower levels. So, we will look to adjust our strategy as value becomes apparent.