AT THE end of last week, equity markets slumped further into the red and some even entered a technical correction – that is, they are now down more than 10 per cent from their recent peaks. The S&P 500 is down 11.1 per cent from its latest high while the UK blue-chip index is off 13.3 per cent.
Politicians might have hoped that the Eurozone stabilisation package would spur on the bulls, but any market euphoria has quickly evaporated, says Paul Niven, head of asset allocation at F&C, an asset management firm. Equally unimpressive were labour market data from both the US and Germany, while a regulatory crackdown has compounded investors’ nervousness.
While some contracts for difference (CFDs) traders might be greedily eyeing up the cheaper markets as an opportunity to buy, Niven is not so convinced. He says: “Despite the pronounced moves across markets, there are worryingly few signs yet of outright capitulation from investors. Given the current bearish mood, this may well mean that downside risks prevail in the short term. Even a few days ago, there were fewer clouds on the economic horizon; recovery seemed sustainable and data was continuing to surprise on the upside.”
“The way that markets are now behaving is suggestive of a move to pricing in renewed and significant economic weakness, and the danger for investors is that market action will begin to negatively permeate economic fundamentals,” he warns. The much-feared double-dip may soon become reality.
Brewin Dolphin’s Mike Lenhoff might be less bearish than Niven, but he too is doubtful that the current level of the FTSE 100 – which managed to hold up just above 5,000 yesterday – is a genuine buying opportunity. He notes that the sell-off in the UK equity market from the April peak only produced a relatively modest dip into oversold territory (see chart).
“This cast doubt on the prospect that a strong rebound lay ahead and that an ideal buying opportunity had been presented. Equity markets have since fallen back and taken out the low point reached two weeks ago. A rebound of sorts may follow but we still have our doubts that a genuine buying opportunity has arrived,” says Lenhoff.
However, Philip Isherwood at Evolution Securities reckons that European and UK equities are now attractive at current valuations. He explains: “Given corporate health and the profit outlook, the near double-digit falls in May leave UK and European equities now looking inexpensive. With the warning that markets can stay cheap longer than you can stay solvent, valuation-wise there are no red lights flashing for European and UK equities.”
Those traders looking for short-term profits or to hedge short positions in physical equities might therefore benefit from going long at current levels. But with volatility still high and the outlook still clouded, those speculating on a sustained rebound in UK and European equities from their current levels may well be disappointed unless they have extremely deep pockets and very steady nerves.
City Index strategist Joshua Raymond notes that many of the buys he has seen are on short-term contracts and this reminds us that traders remain quite jittery. He adds that the sovereign debt crisis is likely to play on investors’ minds for some time and this may make future gains prone to bouts of profit-taking.
More attractive may be the US equity markets, about which Brewin Dolphin’s Lenhoff is more optimistic. In his view, the fundamentals are more supportive for the equity market than expected – he points to the broad-based recovery in corporate profitability, which is no longer just about cost- cutting and restructuring. Revenue is growing and jobs are now being created, which increases both the likelihood of and confidence in a sustainable expansion.
What’s more, two-thirds of the overseas earnings of S&P 500 companies come from areas of the global economy that are growing faster than both the Eurozone and the UK. On the basis that the news flow for the US equity market remains positive, Lenhoff thinks that valuations on Wall Street are attractive.
While any number of factors could drive equity markets even lower from these levels into a sustained double-dip, speculative CFD traders looking for a short-term profitable rebound from the recent sell-off may well be best off looking across the pond.
FOCUS | VOLATILITY
“High volatility may well be the order of the day,” says David Jones, senior analyst at IG Index – and it’s not going away any time soon.
The S&P volatility index leapt to its highest level since May 2009, spiking to 48 on Friday before falling to 36.5 on Monday. Meanwhile, Europe’s fear index also closed higher at 42.6 yesterday. Volatility indices measure the expected percentage by which stocks will vary over the year. The jumps mean that volatility indices on both sides of the Atlantic have doubled from just a month ago from highs of 16 for the VIX and 23 for Europe.
Markets have not been so volatile since March 2009 and indices now stand at just over half the levels reached in the autumn of 2008 after Lehman Brothers collapsed. Without significant reassurance from governments, Jones expects both European and American volatility to stay high as the sovereign debt crisis continues: “There are so many unknowns with this European debt situation and that’s what’s worrying people,” he says.