After the Storm

A kind of calm has returned to global stockmarkets after the August sell-off, triggered by fears about the Chinese economy and its impact on global growth. In the last few weeks I have had time to selectively digest the many commentaries from fund managers. There is a wide spread view the crash was overdone, no surprise there, but nonetheless there is a recognition there are real economic problems in China, notably slowing economic growth and a debt mountain which has fuelled investment and the property market. That said a worst case scenario is that growth in GDP in China in 2015 could be 3%. At this level the Chinese economy will still contribute to global growth whilst exports to China from the US, UK and Europe are comparatively small; intra-Asian trade is more significant. Finally a further sell-off of commodities and energy, a natural reaction to China’s woes is a tail wind for oil importing economies and consumers.

Policy decisions in China and the US have been criticised. One commentator from Schroders suggested that the US Federal Reserve has been dithering over the start date for raising interest rates and should have already commenced the cycle. The sell-off in August could push the expected start date back to December or into 2016. The interesting point is not so much the significance of a 0.25% or 0.5% rise in rates, the markets are fully expecting these, but the message that central bankers are giving out.  A rise in rates is a positive sign that the US economy is firmly recovering and should therefore be welcomed by the markets, whilst ongoing delays show the Federal Reserve do not think the US economy is strong enough to handle even a 0.25% rate rise. It reinforces a belief the US economy is still fragile. Talk of further QE enhances this view. It is very similar to the taper tantrum of May 2013 when Ben Bernanke, the then Chair of the Federal Reserve suggested QE might be coming to an end. It should have been a vote of confidence in the US economy; instead it triggered a sell-off in global assets.

In the current market, valuations of equities have become more attractive and some of my clients have been true contrarians and invested cash, buying into equities when everyone else is selling. There is still a consensus that Europe and Japan are the best markets for equities. I also remain very positive about smaller companies. You may be surprised to learn that UK smaller companies fared much better than large caps during the equity sell-off. The average Investment Association (IA) UK Smaller Companies fund returned 0.1% in the last three months (Source: FE Trustnet, 8/9/15). In contrast the average return from the IA UK All Companies sector was -6.9% over the same period. These funds are more dominated by FTSE 100 companies. The explanation is very simple – many large companies and mega-caps have the majority of their earnings overseas and are much more geared to global economic events whilst smaller companies are oriented to the domestic and consumer economy. In an environment of improving wage growth and increasing consumer confidence in the UK, small caps are expected to outperform globally sensitive stocks. I welcome the differential market response as it indicates that investors reacted objectively by not indiscriminately dumping smaller companies.

Finally there is a clear disparity in developed markets on equity valuations between defensive growth sectors and stocks and more cyclical economically sensitive and value stocks. The former include consumer staples, food and beverages and healthcare. Investors have naturally piled into defensive growth stocks in recent years in a hunt for returns but value stocks and cyclicals are more attractively valued. These include commodities, energy, industrials and banks.  The point here is that there is a danger of labelling a stock market as a whole as expensive and dismissing any further investment, for example in US equities. That said the catalysts for value stocks, sectors and markets (including emerging markets) to rally are generally not evident.

This blog is intended as general commentary on global stockmarkets and reflects my own views. It is not an invitation to invest in equities as these may not be suitable for your financial circumstances or your risk profile. You should seek individual advice before making investment decisions.