The recent movements in stock markets around the Globe (since Friday night in the US) have given us much cause for concern.
Stock markets have continued to trade down while bond prices have lifted following heightened fears of a growth slowdown in China. The correction started after China devalued its currency by pegging it to the market. This is what the developed world has been asking of China for many years, however, the timing was anything but brilliant! At the time, there was enough doubt about China’s motivation behind the move, leaving open the possibility that the adjustment in the currency was simply part of a planned liberalisation of its currency market. But the steady fall in global commodity prices and weak Chinese manufacturing updates have now moved attention and concerns to its economy.
Is the fall simply a correction in a sustained medium-term bull market, or the beginning of the end of the cycle? In our view at the moment, we see it as a correction, but in a multi-year rally that is losing steam.
Two prominent risk factors could end the economic and risk market cycle: a surge in inflation which requires the Federal Reserve to raise the cash rate more aggressively and to a higher level than currently expected; and an emerging markets debt crisis. The recent selloff is, in our view, a reaction to China’s market volatility and currency devaluation (amid struggles for emerging markets more generally), oil prices’ drop to multi-year lows, and worries of potential Federal Reserve (Fed) interest rate increases. Regarding potential rate increases, we believe recent events may make the Fed less likely to take action in the coming weeks. We believe that none of these factors are likely to derail the long-term global economic expansion. At the same time, market catalysts such as these are unlikely to disappear, we believe it underscores the importance of the need to be risk–aware and strategically allocated.
While it is inevitable that short-term volatility and market drawdowns can cause angst for investors, it is not all bad. It is important to remember that with volatility also comes opportunity and this period of weakness has been no exception. The Australian equity market now looks better value than it has for some time, trading at 14.5 times one year forward earnings. Despite the reasonable valuation, we believe a selective and focused approach remains key to uncovering good long-term opportunities.
Aziz Meherali CFP