October’s market turbulence provided a number of challenges and lessons for investors, who have grown used to the steady rise of both global equity and bond markets.
However, following monetary policy intervention from Japan, stronger rhetoric from Mario Draghi and verification of robust US growth, our concern for the potential for a larger correction has moderated for now and we are again selectively overweight equities in our funds.
Escalating concerns about the outlook for global growth and the risks over disinflation drove the fall in stockmarkets. Inflation and growth expectations materially fell across the developed world in October, economic data was weak and the International Monetary Fund downgraded its growth forecasts.
From a medium-term perspective, market action in the past few years has often hidden the lack of progress in deleveraging, as well as the development of structural reform in Europe.
The world remains highly indebted, albeit more focused at government level; and while quantitative easing has been highly effective in boosting asset prices, its effect on generating aggregate demand and inflation is less certain.
Despite these risks, we reinstated the pro-equity position selectively across regions. We expect the global economic cycle and corporate profitability to remain intact.
Evidence of market stabilisation, and the alleviation of our concerns over potential policy vacuum following the Bank of Japan (BoJ) action and stronger rhetoric from the European Central Bank (ECB) were enough for us to move to overweight equities.
The action from the BoJ was material, supporting the risk trade, but more importantly the outlook for Japanese equity markets in local terms.
Corporate data continues to be relatively supportive of equities as earnings and results have been decent. Globally, corporate data is not a headwind to equities – balance sheets are healthy, earnings revisions are stable and profitability is unlikely to collapse.
So how are the next six months looking for investors? Looking at the medium-term inputs, economic activity is still strong in the US, favouring US equities and high yield compared with US Treasuries. The end of Federal Reserve quantitative easing indicates policy is neutral for most US assets, which will then shift the focus back where it should be – on economic data.
In the eurozone, weaker economic momentum is proving more supportive of eurozone fixed income. The expansion of the ECB balance sheet – as well as the potential for additional monetary announcements in the coming months – is positive for both eurozone equities and fixed income.
So, while intervention by central banks in Japan and Europe, continued US economic growth, and strong global earnings generally are supporting the market, the underlying factors that caused the recent correction remain.
Debt levels remain high in the developed world and the low growth and low inflationary environment may persist for longer. These factors contribute to why reactions to deteriorating growth and inflation expectations create material moves within markets. Investors should be prepared for more volatility in the medium term.
