Yesterday’s dramatic moves in stock markets around the world, coming on top of the pronounced market volatility of recent weeks, will have concerned investors, with the lack of a single clear trigger making it harder to assess the potential for this volatility to be sustained.
While the fluctuations we’ve seen over the last few days are indeed a cause for concern in the shorter term, however, the overall outlook for equities remains positive. For tactical investors, there could be some opportunities to buy equities in the coming days.
But this is risky business, and most savers should remember that diversification remains key for riding the bumps of stock markets over the long term.
What’s causing volatility in equity markets? There are a number of forces driving the fluctuations we’ve seen over the past week. The devaluation of the renminbi this month, which triggered a broad sell-off of emerging market assets, has led to a spill-over of negative sentiment into developed markets.
Broader fears over China have certainly impacted emerging markets, which also face pressure from US dollar strength and the prospect of Fed rate rises – as well as the recent slump in commodity prices.
On top of these, thinner markets during the summer holiday period mean that movements can be amplified by low liquidity, and there’s likely an element of this here.
Despite the panic of recent weeks, however, the outlook for the world economy has not significantly changed. From a fundamental perspective, the low growth/low inflation paradigm remains and is broadly supportive of equities. Loose central bank policy also supports this picture, particularly in Europe and Japan, and, while all eyes will turn towards the Fed, the US central bank is treading carefully and is unlikely to hike in September.
Of course, plenty of risks remain. The pace of China’s slowdown has brought some surprises and continues to impact commodity prices overall. However, the transition to a more sustainable, consumption-driven model of growth has been happening for some time.
While China’s export and manufacturing sectors are struggling, its service sector continues to expand and become more important. None of this structural transition was ever going to be a smooth ride, and its impact on both developed and emerging markets will continue to be felt.
On top of this, ongoing concerns around the Fed and the prospect of higher interest rates are likely to sustain pressure on emerging markets assets and, if we see emerging market corporates (particularly in vulnerable countries such as Brazil, Russia and South Africa) blow up, then current concerns could become more serious.
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But in recent weeks, many active equity managers have begun to add to risk assets. Indeed, our team’s sentiment indicators are suggesting that now could be a good time to increase equity exposure, given the mood in markets, more attractive valuations and unchanged fundamentals.
It is vital to proceed with caution: jumping into equity markets can backfire, and it may pay to begin building positions over the next four weeks, rather than piling everything in now. This environment calls for a careful and actively managed approach.
For example, equity portfolio managers with solid stock-picking skills may be able to find opportunities in companies with positive long-term prospects. I think Europe and Japan look the most attractive from a regional perspective, and volatility has helped to reduce valuations here.
Of course, equities aren’t the only game in town. Investors can help mitigate volatility in their portfolios over the longer term by diversifying their investments across a broad range of asset classes, using multi asset portfolios to spread risk even further.
While we have seen equity markets fall in recent weeks, bonds have performed relatively well, and the traditionally negative correlation between these asset classes can help protect a portfolio from volatility.