Developed market equity correction is called by Chris Godding at Signia Wealth

Chris Godding, head of Global Equity at Signia Wealth, says that the recent highs seen on indices such as the FTSE 100 and prices of developed market equities suggest investors should be looking at emerging markets.

It is a given that the equity markets have been driven by excess financial liquidity and that valuations have been able to normalise now that the central banks have removed the “tail risk” of a liquidity driven collapse, particularly in Europe. However, the degree of appreciation since last summer has eliminated much of the excess risk premium available to investors, implying that we are in the later stage of this particular bull phase rather than the beginning. Our assessment is that investors have essentially “paid up front” for the benefits of liquidity, and we would not be surprised if the disconnect between the market and the economy in the short term leads to correction in equities.

We are struggling to identify the catalyst at present, but it may simply be that buyers get exhausted in the short term, just as sellers get exhausted in bear markets. In this context, a 5% correction would be a healthy consolidation and pause for the real economy to catch up and act as a foundation for the next leg. Our models at the start of this year suggested annualised returns from equities of close to 10% for the next three years and those targets remain valid today. The fact that we are up 15% in the UK in five months implies that we are ahead of the return curve, but there is no rule that dictates the returns will be spread evenly over the three year horizon. The risk reward for investors with a three year time frame remains good relative to cash, bonds, corporate debt and high yield and a 5% correction would make that return potential even better.

If investors are keen to get involved, we suggest that the unloved emerging markets offer a good entry point at current levels. Central Europe is highly geared to a recovery in Europe, which is being rapidly discounted by European investors. Falling commodity prices may be bad for the top line in some countries such as Brazil and Russia but they relieve inflationary pressures for the emerging consumer in India, China and many other resource importers.

Therefore developed markets are due a correction, outlook looks good on a three year time frame and investors should look to emerging markets.


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