After a wild week, what's the outlook for world equities?
Don't despair, says James Daley; the canny investor can find opportunities amid the mayhem
Saturday 26 January 2008
Growing fears of a global recession finally caught up with the world's stock markets this week, sparking the biggest daily fall in the UK FTSE 100 and US S&P 500 indices since the September 11 terrorist attacks in America more than six years ago.
A series of bad economic data from both sides of the Atlantic, combined with the perpetual string of negative news about the credit crunch, have eaten away at investors' confidence over the past few months – and, while the Americans were on holiday celebrating Martin Luther King Day on Monday, the bottom finally fell out of all the major Asian and European equities markets.
Although the US Federal Reserve reacted instantly by slashing its interest rates by 0.75 percentage points on Tuesday morning, it was not enough to avert heavy falls in the US on Tuesday. However, as the week went on, the markets rallied sharply.
For private investors, the scenes understandably stirred memories of the last bear market in equities, which saw most of the world's mature markets halve in value between 2000 and 2003.
However, the drivers behind the current market volatility are very different. While most observers are warning that 2008 could be a very tough year, the advice for investors from most financial advisers and professional investors is to sit tight – and maybe even to add to your holdings when the markets take a dive.
Here, we take a look at each of the major regions of the world and the outlook for the months ahead.
The FTSE 100 fell by more than 5 per cent on Monday, bounced by 3 per cent on Tuesday, fell more than 2 per cent on Wednesday, and then jumped again, by more than 4 per cent, on Thursday. If you were one of the canny investors who picked up some bargains at its lowest point, you might have finished the week feeling quite pleased with yourself. However, it is by no means certain that we won't see even sharper falls in the weeks ahead.
"Volatility tends to be followed by volatility," says Robin Geffen, chief investment officer of Neptune Investment Management. "And I believe quite a lot of good stocks came down along with the bad this week. But for the average investor, the worst thing you can do is try to trade your way out of this sort of market. It's desperately risky to buy on a euphoric day and sell on a depressing day – you've got to look at the fundamental value of companies and hold them for the long term." Michael Gordon, the head of investment strategy at Fidelity Investments, agrees. "Tempting as it might be to withdraw money when markets drop sharply, this merely crystallises an individual's losses," he says.
Most fund managers agree that UK valuations are still historically very low. While economic conditions are forecast to get worse, it can be argued that a worst-case scenario has already been priced into many stocks.
Mark Lyttleton, the manager of the Black Rock Absolute Alpha fund, points out that the shares of housebuilders have halved in value in six months. "In the early Nineties, housebuilders took two years for their share prices to halve; this time, it took just six months," he says.
"The fact is that the ramifications of the credit crunch are far-reaching and will be with us for some time. But when all seems gloomy, there are normally opportunities to be seized. If investors have cash they may wish to consider dribbling it into the market, buying high-quality funds on a three- to five-year view when the market is having a bad day."
Gordon says that his fund managers are now even considering getting back into financial stocks after the heavy beating they have taken in recent months. However, Geffen cautions that there may still be bad news to come from the banks, even though they are now at very low valuations.
Ultimately, the UK looks in better shape than the US. And, unlike the Federal Reserve, the Bank of England has not let itself be held to ransom by the markets.
Although further interest-rate cuts are probable, they are likely to be smaller and less frequent than in the US – and this may ultimately increase their effectiveness, both at injecting some confidence into the markets, and at controlling inflation.
The Federal Reserve's emergency interest-rate cut on Tuesday was the biggest single rate cut in the US for more than 25 years. Many economists and investors claimed that it smacked of panic. And, while it was successful in preventing a prolonged dive in US stock markets this week, experts are divided on whether the move will be positive in the longer term.
Given that the Federal Reserve has already admitted that the US economy is facing inflationary pressures, a sharp rate cut (which will cut companies' and home-owners' borrowing costs and put more money into their pockets) may allow inflation to creep up, and leave the economy much less stable.
Nevertheless, James Abate, manager of the Psigma American Growth fund, says he remains confident about the prospects for the US market. He claims that, while it may be a while before he's ready to jump back into financial stocks, he is now positioning himself for a recovery in the industrial and technology sectors, and is keeping his focus on the larger multinationals. His largest holdings currently include the oil giant Exxon, Johnson & Johnson, Google and Procter & Gamble.
"Very simply, we like value-added things that get sold into emerging markets – planes, cranes, technology, even cosmetics and cola, as well as things that we buy from the emerging markets, principally oil," he says. "We're using the market's weakness to accumulate positions in these areas, further expecting them to lead the market's advance as fears subside."
It should not be forgotten that the US has been and is at the centre of the global financial crisis, and there may be more bad news to come. This week's news that some of the monoline insurers – who insure the debt of other companies – are running into trouble is another angle to the credit crunch that had not been considered.
Nevertheless, US markets have already taken a big hit. Braver investors may find, with hindsight, that now was a good time to start getting back into the more defensive stocks.
Europe's main markets fell faster and further than Japan, the UK and US at the start of the week – a fact that was initially hard to explain. But when news of Société Générale's $7.1bn (£3.6bn) fraud emerged on Thursday, some investors suggested that the French bank may have been a contributing factor in Europe as it tried to unwind some of the positions its rogue trader had landed it with.
Ultimately, the pressures in Europe are similar to the UK and US. The major economies are slowing, consumer spending is retracting and it is still unclear exactly where the fallout from the credit crunch will end.
Europe is, however, one step removed from the US and in slightly better shape – and the faster growth of the emerging European economies offers strong prospects for investors in the medium to long term. Again, keeping calm and sitting tight is the order of the day.
Japan has seen slower economic growth than the rest of the developed world over the past few years, and progress in its stock markets has been more muted as a result.
Andrew Milligan, the head of global strategy at Standard Life Investments, says that while the drivers of the collapse in Japanese markets this week were similar to those in Europe and the UK, there may have been some additional concerns about how the weaker Japanese economy would handle such strong headwinds. However, he added that more of the bad news was already priced into the Japanese market.
Lincoln Financial Managers claims that Japanese equity valuations are now at 33-year lows, and that the market offers incredible value. Although the market may remain volatile over the coming year, it presents good value for investors with a long-term outlook.
One of 2007's hot debates was whether emerging markets were "decoupling" from the US. As the biggest economy – and hence the biggest consumer – in the world, the US has historically been the main driver behind both good and bad performances in the emerging economies.
However, over the past few years, the economies – and stock markets – of countries such as China, Russia and Brazil have been booming, while progress in the US has been much more troubled.
The events of the past week reiterated that – while decoupling may be taking place – the link has not been severed yet. The Hong Kong Hang Seng index plummeted 14 per cent on Monday and Tuesday, only to gain more than 10 per cent on Wednesday on the back of the US's interest-rate cut. A similar picture emerged in most of the world's emerging markets, with sharp falls followed by considerable rallies on the back of the positive US news.
However, Robin Geffen of Neptune insisted that the decoupling phenomenon is still very real. "We saw some profit-taking in China in the first quarter of last year, so I don't think it's too unexpected to see some falls in these markets," he said.
Geffen believes Russia now represents particularly good value, claiming that many quality stocks are trading on price/earnings ratios of less than 10.
Aberdeen Asset Management said the sell-offs in the Asia-Pacific region reflected concerns over the trickle-down effect of the credit crisis, claiming that many investors had taken shelter in the region towards the end of last year due to its strong economic fundamentals, but were indiscriminate about which companies they invested in. As a result, the valuations of some businesses became inflated, and a sell-off became inevitable.
"We expect the nervousness that has been building in markets for the past couple of months to continue, with investors in Asia watching for signs of an exports slowdown," said Hugh Young, managing director of Aberdeen Asset Management Asia. "While some sectors and markets now look vulnerable to further corrections, others still offer decent value to high-conviction stock-pickers such as ourselves."
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