#Market Strategy — 25.08.2015

Stormy Weather on Equity Markets

Florent Bronès

A global growth scare has led to a sharp drop in equity markets and to what some are calling a China Black Monday.

A growth scare

Since their May high, global equities have lost nearly 14% (MSCI World AC index). Commodity prices also began their descent in May - especially oil, which fell from USD 68 to USD 43, heightening deflation fears -while global government bond yields followed the same trend from early June. The common denominator between these trends is fear about the health of the global economy. China’s recent decision to change its currency regime has been the catalyst for a deepening of those worries, which resulted in yesterday’s steep declines in stock markets.

The outlook for the global economy is not as dire as investors currently fear. Among the factors that speak for a continued acceleration in economic activity in developed countries we will mention household formation, wages and jobs in the US, the high level of consumer confidence in Europe and in Japan, backed by the ultra-accommodative stances of the ECB and BoJ.

Because of structural issues, the outlook for emerging countries remains negative in coming months but some stabilisation should progressively be seen, based on some positive influx from developed countries and selfhelp initiatives.

The bottom line is that past reflationary efforts and new budgetary and monetary initiatives should in the end have the  upper hand over deflationary fears.

We remain buyers on dips

Yesterday’s steep declines look like being a selling climax: trading volumes have jumped, the put-call ratio has reached record levels, the volatility indicator VIX has jumped from 13 to 40 (and even 50 intra day)… Volatility in the short term is likely to prevail but we believe that by year end stock markets will be higher. First of all, and most importantly, earnings are on an improving trend. Second, dividend yields of 3.60% in Europe, 2.70% in the US or 1.70% in Japan compare very favourably with bond yields. Third, the outlook for a Fed rate hike being delayed to December, in the eyes of the consensus, should provide some relief. Finally, when signs that the global economy is effectively recovering gradually impose  themselves, investors should come back into equity markets.

We remain buyers on dips, of developed stock markets (euro area, Japan and the US). By year end, stock prices should have regained some colour. In the short term however, markets are likely to stay volatile. In other words, after the recent storm, and after a while, quieter waters and the sunshine should come back.