The Current Weakness in Equity Markets
Global equities have again had a bad day yesterday, for a fifth consecutive day.
All began with the Fed's decision to keep its benchmark rate unchanged and to issue a very dovish statement, fuelling a return of growth/deflation fears. These have then been nurtured by the release of Markit's manufacturing PMI for China, which fell to 47, its lowest level since March 2009 and by Caterpillar's announcement of cost-cutting measures that will include job losses of up to 10'000 over four years.
Other casualties of the return of growth/deflation fears
Over the last five trading sessions, not only equities have lost ground. Emerging market currencies have lost 2.5% on average, base metals and oil prices have declined by, respectively, 4.5% and 3.7%. Government bond yields have gone down as well: the US 10-year Treasury bond yield went from 2.30% to 2.10%. Corporate bonds have seen their spreads widening. Finally, the Volkswagen scandal has added fuel to the fire and brought euro area stock market indices below their August lows.
Perception versus reality
Sentiment is heavily tainted by a focus of attention on manufacturing activities, the most volatile component of any country's economic activities. There is no denying that manufacturing activities suffer heavily. The main causes are the steep spending cuts in the oil industry and the structural change in economic models of emerging countries. However, services are a more important segment of any country's economy and there indicators such as PMI surveys indicate continued expansion. We keep believing that the global economy will stay in its growth tracks. Reasons for not being too negative are plenty. In the US for example, job market and wage trends are positive, housing data are strong, new orders are rising, guidance from companies is for an improvement in sales. In the euro area, monetary aggregates and credit activity are strengthening, corporate and consumer confidence are well oriented, competitiveness has been boosted by an 18% decline in the trade-weighted value of the euro since the beginning of 2014 and new orders in Germany remain at very high levels. In Japan, business confidence is good, wages are rising (albeit timidly) and new stimulative measures are expected. In China, house prices are rising, the services PMI is above 51 and consumption indicators are positive; we expect a recovery in spending by local authorities and positive news from October's 5th plenary session of the 18th Central Committee of the Communist Party. Finally, we should not forget that G4 central bank balance sheets will remain in expansion mode despite the Fed's intention to begin raising its benchmark rate before the end of the year, as Janet Yellen explained last night as well as four regional Fed presidents over previosu days. The BOE should follow in 2016.
Investment strategy unchanged: recommend taking advantage of erratic stock market movements to buy based on the belief that a resumption in the primary uptrend will follow
In the near future, we do not see what could lessen growth/deflation fears. Volatility is likely to prevail. Increased risks of a US government shutdown and on the debt ceiling will not help. Before year end however, those fears should have begun retreating, with signs of stabilisation in manufacturing indicators and with the better trends in non-manufacturing activities being taken into consideration. We believe that current stock prices are attractive with valuations back to their averages of the last three years and that they will be higher in the next 6 to 12 months.