Market Outlook
World equity markets have suffered a correction in the region of 20% since hitting cyclical highs in April. This amounts to more than $8 trillion being wiped off the value of world stocks on concerns the US would default on its debts, S&P’s decision to downgrade USA’s AAA rating, another batch of weak economic data releases, the IMF revising downwards global economic growth forecasts, markets driving bonds yields on Spanish and Italian papers above the critical 6% ceiling which would hamper their ability to repay debt and the Euro-zone debt crisis which could lead to the disintegration of the Euro.
There is also genuine concern about the sustainability of the US recovery, the ability of policymakers’ to tackle the debt and the prospect of a double deep recession. Policymakers and central banks have been criticized for being caught napping and responding too slowly to the crisis and the ECB in particular for tightening interest rates too quickly when the recovery is still fragile.
Meanwhile the global risk appetite index which is a broad measure of investor confidence hit an all time low in August which exceeded previous “deep panics” in August 1982, October 2002 (the dotcom and 9/11) as well as November 2008 (credit crisis) which implies markets are “heavily oversold.”
The sell-off is purely a reflection that the markets face stronger headwinds in the aftermath of the credit crisis than previously anticipated due to global debt levels, debt deleveraging and global economic rebalancing; which in turn has led to a dip in consumer confidence and which could potentially reduce corporate spending plans and trigger a double dip recession. In our view this is highly unlikely but of course the risk is that consumer spending which accounts for two thirds of many developed economies is adversely affected by declines in consumer confidence triggered by the market volatility. It is almost like the markets precipitating a recession or a case of “the tail wagging the dog!”
Conclusion
The global economy faces a period of below trend growth with strong headwinds caused by debt deleveraging, fiscal tightening and global economic rebalancing. Even though we are of the opinion that a double dip recession can be averted there is a risk that complacency, inaction and lack of coordination by the EU, G7 and G20 may lead to a crisis of confidence which, if allowed to fester, may have a damaging effect on consumer spending which accounts for two thirds of many developed economies. This coupled with falling equity prices may just push the global economy over the cliff. We are concerned that the mismanagement of the EU crisis may have a contagion effect but we do not subscribe to the view that the authorities are running out of tools to address the problem if anything they are running out of time.
Markets are driven by people and the herd mentality often takes over clouding many of the issues we face. The EU crisis has the potential to trigger a double dip recession but if properly managed equity markets should recover from here. Investors’ who are able to withstand the short-term volatility, take a long term view and who have or are thinking of re-entering the markets following the sharp fall in prices will find valuations at very attractive levels with price-earnings multiples in single figures and excellent dividend yields.
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