Market correction doesn’t spell end of bull run in stocks
Animal spirits’ are working in reverse as equity weakness ignores supportive fundamentals, according to Paul Craig, portfolio manager in Cirilium portfolios.
It is hard to find a good reason for the turbulence ripping through financial assets of late. One section of the Chinese market has been rocked by intense volatility, and yet this is having a huge impact elsewhere. Investors appear to see the rout in Chinese shares as suggesting the world is in the midst of a full-blown growth scare, with China at the epicentre.
And yet despite fears of a hard landing for the Chinese economy, monetary trends suggest it has an improving backdrop. According to JPMorgan, domestic housing data are stabilising, repo rates are steady and no further material depreciation in the currency is likely soon – while further stimulus is likely. Meanwhile, the European Central Bank and Bank of Japan are still pumping liquidity into the market. Europe, long a drag on the global economy, is now recovering. And surely much of the weakness in emerging markets should have already been priced in.
It appears that what we are seeing are the famous animal spirits of economic theory – but working in reverse. Still, it remains unclear whether many investors are actually behind the market declines. Much of it may be due to algorithmic traders and passive funds whose investment mandates force them to chase markets down.
It is not believed that we are witnessing end of the multi-year rally in risk assets. Yes, that bull-run is looking a little long in the tooth – but we’re not in a normal market cycle. While interest rates are at rock bottom, consumers and corporates have exploited them either to repay debt or refinance at lower rates – rather than taking advantage of low rates to borrow more. Other metrics, such as capital expenditure and M&A activity, point to the cycle being at different stages.
These signals, and the fact that another recession or financial crisis is probably not around the corner, mean the market falls are most likely just a correction. Some markets had simply got a bit ahead of themselves, and are now giving back gains amid thin summer liquidity. It may well be that if the US Federal Reserve refrains from raising rates in September, investors turn on a sixpence and buy back in.
Very few funds will be completely insulated from the turbulence. Government bonds no longer provide the buffer one would have expected, as yields are so low as to make them expensive. This means investors are either invested in traditional risk assets, or are in cash.
There is more volatility expected going forward, though possibly not to this degree. But the general view on the outlook for the rest of the year remains: a modest economic rebound is still likely. Within the US and Europe, funds will look to top up those areas that have been unfairly hit in this correction. Within emerging markets and Asia, allocation will be a lot more gentle because the whole region is under a cloud – and a bigger catalyst would be necessary to make them more bullish.
The value of the investment can go down as well as up and you may not get back as much as you put in.