What has triggered the sharp falls in equities?
You have probably seen all the recent newspaper headlines declaring ‘FTSE now officially in a bear market’ after a 20% decline from the highs of last April. Whilst the FTSE has suffered from its high exposure to commodities, other markets have also experienced significant falls. The views of the more bearish commentators, who are in a minority, have received disproportionate coverage which may have served to heighten the sense of unease among private investors.
What unsettles stock markets is uncertainty and we have that in abundance. We highlighted the drivers behind the economic slowdown in China
, reduced demand for commodities
and the oil price
slump in some of our blogs last year. Today these same worries persist compounded by divergent Central Bank monetary policy and the added distraction of the EU referendum in the UK and a US presidential election.
These issues have undoubtedly had an impact on both business investment and consumer confidence and the IMF has trimmed its global growth forecast further to 3.4% for 2016. A warning from the International Energy Agency that the oil market could “drown in oversupply” did not help sentiment.
Is there any good news ahead?
The muted outlook for growth may prompt further monetary stimulus in China, Europe and Japan while in the UK interest rates look set to be on hold for the rest of this year and any increases in the US should be gradual.
On the positive front China’s preliminary GDP growth for 2015 came in at 6.9%, in line with Government expectations of around 7%. Although manufacturing data has been persistently weak, as it transitions from an industrial to consumer driven economy, the slack was made up by a strong performance from the services sector.
The outlook for consumer spending in major markets also remains positive if the combined effects of low interest rates, cheaper oil, falling unemployment levels and rising real wages boosts consumer confidence and translates into higher spending and overall growth this year. A resultant positive earnings season would be encouraging for equities.
The UK saw the first indications of a pick up in inflation in December and if the trend continues it should remove the negative implications of a deflationary environment. Saudi Arabia has described the drop in oil prices as ‘irrational’ and expects a recovery in 2016 even at current OPEC production levels.
Is now the time to buy?
Recent turbulence serves as a reminder that investing in equities requires a long term horizon. The chance of long term outperformance compared to lower risk asset classes entails acceptance of greater amount of volatility, a measure of risk. Volatility was reduced during the era of quantitative easing (QE) and we are now seeing a return to more normal levels.
Volatility is not always a bad thing; just as stock markets have dropped sharply they can stage a rapid recovery if the outlook improves. Another full blown economic crisis seems unlikely and the general view seems to be that we are seeing a sentiment driven correction rather than a signal of a longer term structural decline in the global economy.
In this period of widespread markdowns in equities, good active fund managers will focus on valuations and fundamentals and seek to buy good companies at bargain prices. Identifying those who have conviction in their process is particularly important in volatile markets.
Whilst there is no guarantee that equity markets have reached a bottom (over history the average bear market has brought declines over 30%) being out of the market when it rises can seriously damage your overall returns. Of course, not all asset classes move together. Prices of high quality government bonds, for example, have risen as share prices have fallen. This supports the argument for a balanced portfolio, spread across uncorrelated assets.
In conclusion, remind yourself why you are investing, ensure you have a well diversified portfolio and perhaps consider drip feeding some money into the market during periods of weakness.
Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.