It has been a tumultuous week for developed equity markets, as investors finally woke up to the reality that the Chinese economy was slowing and that the 7% GDP growth numbers that have been touted by the Beijing authorities seem somewhat exaggerated. As to why developed markets took so long to come to this realisation is an interesting point, particularly when one considers that emerging markets, their respective currencies and commodities have been weak all year and a number of them are presently in bear markets.
One could cynically argue that perhaps the latest sell-off had nothing to do with China (after all, its slowing growth is hardly new news) and more to do with concerns that the US Federal Reserve (the Fed) is or was entering a tightening interest rate cycle. After the latest market falls, with the Dow Jones now down 15% from its high (as I write this article) the futures market is pricing in a very low probability of an interest rate hike in September. Indeed it is hard to imagine that Fe Chair Janet Yellen will now look to raise rates in the current environment, for she understands how important US stock markets are to consumer and business confidence and in turn to subsequent GDP growth.
So, if markets should have known about China and can’t now be worried about the Fed tightening, why are we not experiencing a V-shaped rally? Perhaps the reason is that investors were, for a very long time, looking for an excuse to take some profits. The bull market in the US is very ‘long in the tooth’ and it has been a considerable number of months since we last saw a correction greater than 10%, which meant it was just a question of time before we witnessed some sort of sell-off.
Share buy backs have been propping up US markets this year and if one looks at the advance : decline ratio, the average stock was actually down for the year prior to this last week’s sell off. Simply put, it was only a handful of “mega cap” stocks that were propping up the market and as Apple’s share price (to give one example) began to fall, we started to see the broader market index come under pressure.
In terms of our strategy in the prevailing climate, we continue to remain focused on our risk management processes and will look to apply tactical asset allocation adjustments to take advantage of instances when investors overreact to events, or when fundamentals change. Importantly, we do not perceive a risk of a global recession based on current economic news in the developed world.
We believe corrections in bull markets are healthy and offer opportunities for long term investors to buy good assets at cheaper prices. In our funds, we de-risked our portfolios prior to the falls and are currently biding our time to buy in at better levels. From a regional perspective, European and Japanese markets continue to look attractive, but we need to see the technical picture improve before we increase the risk in our portfolios. Patience is the better part of valour and China does remain a concern, especially when one considers the authorities’ increasingly desperate measures to shore up their stock markets and economy. Valuations for quality companies are still not cheap, so for now we are keeping our powder dry.
Keep Calm and Carry On
