Legal&General: “Don’t lose your head”

In recent days financial markets have tended to side with an alternative ending to Kipling’s famous poem, “If”, from the TV character David Brent: “If you can keep your head when all around you have lost theirs, then you probably haven’t understood the seriousness of the situation.”

The LGIM Asset Allocation Team believes it is important to be calm and to understand the seriousness of the situation. Market moves since the start of the year have certainly highlighted the risks of investing in equities, but they believe that this is an environment with opportunities for medium-term investors. Emiel van den Heiligenberg, head of Asset Allocation at LGIM, comments.

“Markets started the year in turmoil, and with the exception of a few moments of relief, have remained tumultuous. What’s different in February is that the focus has switched from China, commodities and emerging markets to developed markets – particularly cyclical equity market sectors and banks (both equity and credit).

“The MSCI World equity index is down around 20% since the 2015 highs. This kind of sell-off is what people usually identify as an equity bear market. We have also seen credit spreads on corporate bonds start to rise and expectations for interest rate hikes in the UK and the US pushed back substantially.

“In fact, there is now a decent chance of an interest rate cut from the Bank of England priced into markets. Have markets lost their heads, or is something serious unfolding?

Are we facing a recession?

“Markets are worrying about recession and the tightening in financial conditions raises the risk that this could be self-fulfilling. In this turmoil, it is important to realise that economic cycles usually do not die of old age and only some of the typical late cycle features are currently present.

“Recessions typically require a combination of excess demand, domestic imbalances, interest rate increases and large external shocks. The external shock which is currently playing out in the markets is that of weak emerging markets growth and rising credit risks, especially in the energy markets.

“So while a number of emerging market economies are under significant pressure, we remain relatively constructive on developed market growth. US household real incomes remain strong, supported by lower energy prices and decent employment growth. The key trigger for recession would be if the corporate sector decided to retrench, making labour market indicators an important area of focus.

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