Global equities: Structural re-pricing or just volatility?
By Nikko Asset Management Global Equity Team, Edinburgh (headed by William Low, Head of Global Equity)
Global equity markets have had a poor start to the year with deterioration in market sentiment and concerns over whether central bank actions can continue to support the global economy. This correction has not greatly surprised Nikko Asset Management’s Global Equity team given the following factors:
1. Equity risk premiums were at low levels having been artificially boosted by years of quantitative easing (QE);
2. Profit expectations had been high, both in terms of growth and scale of profitability;
3. China has raised the stakes in the global game of competitive currency devaluation; and
4. Global emerging market debt and anything energy or commodity related have proven to be a ‘busted flush’.
However, the scale and pace of declines have been severe. The deterioration in credit markets along with equities is providing a clear bearish signal to investors, which is driving a negative spiral of liquidation and unwind. This places us in a quandary since the current market phase of “selling winners” and shorting key indices/ETFs is making equity markets quite indiscriminate at the stock level.
As a result, we have a tough call (and not for the first time) to address whether this is creating a market backdrop where patience will be rewarded and just following volatility/rotation is a ‘mug’s game’, or whether a structural deflationary re-pricing of equities is taking place to force the hand of central banks to adopt further rounds of monetary inventiveness.
‘Stick tight’ thesis: what would support this strategy?
Markets have been declining for a sustained period, with the S&P 500 Index (USD) at 147 days since its peak and the MSCI AC World Index at 193 days since peak (as at 16 February). In terms of the scale of declines, the S&P 500’s fall does not look that significant versus history (see Chart 1).
Chart 1: S&P 500 Index (USD) since 1990
However, given the concentrated nature of the market in recent times, the broad equally weighted index shown in Chart 2 gives a better indication of what is being discounted in the average stock. This highlights that we are getting close to the minimum 29-37% drawdown seen in major market falls in recent decades.