Hindsight is a wonderful thing, but the recent correction in stock markets was hardly surprising. Even its extent and volatility were not totally absurd when you take account of a few crucial factors.
The most relevant factor is that this all occurred in the summer when volumes are thinnest. Moves were therefore larger and more prolonged than perhaps they otherwise would have been in normal trading.
While European traders started filtering back last week, the US summer only officially ended yesterday, so we still don’t really know what the majority of traders feel about current levels until we are some way through September.
The main reason for the correction is down to how strong markets have been in the short and long term, despite uninspiring fundamentals.
European and Japanese equities had been unashamedly strong this year, supported by central bank bond-buying programmes, and US equities, while mixed, had not been particularly negative.
That’s the short term. In the long term, markets have been fantastically strong since March 2009, all of which has been stimulus-led, and that stimulus is getting closer to being removed than added to in the all-important US market as the Federal Reserve gets ready to hike its interest rates.
China clearly has had a big impact over the last few months, though I consider that to be the spark for the correction, not its cause. I am bearish on China, but not because of the Shanghai market correction.
China’s equities were not correlated with fundamentals on the way up and so, on the way down, they do not necessarily imply that the fundamentals are weakening.
However, the Chinese economy is slowing and, as I have warned before, I am sceptical as to where it can settle and expect a much larger and sharper correction than most factor in.
I have been told more times than I care to count on Worldwide Exchange that equities are attractive relative to other assets. Relative attractiveness is all well and good when there is confidence in the market.
But as soon as you have a risk-off moment, investors are quickly reminded that equities (and emerging market currencies and commodities) are risk assets, and will not escape negativity whether yields are higher than bonds or not.
Given the run over the last six years and that developed world growth is only around 1-2 per cent (a level that hardly justifies the global quantitative easing programmes), most risk assets are not attractive in absolute terms.
This summer, China sparked a re-evaluation by investors of the long-term fundamental attractiveness of the assets they were holding, and we duly saw a volatile correction.
MORE VOLATILITY AHEAD
I imagine this is not quite the full end to the post-global financial crisis bull market. There will probably be another (volatile) leg to the uptrend, no doubt caused by further dovish sentiment from central bankers – the statement from the European Central Bank’s Mario Draghi last week is a good example.
But ultimately, on any long-term perspective, do we really think that economic growth rates of about 2 per cent are enough to judge QE a success? Not for me. The fundamentals do not justify the action of the last six years.
Thus the market rally we have seen is resting on either a sharp improvement in global fundamentals or more dovish action (not just rhetoric) – which would be increasingly ineffective, as China has clearly highlighted.
With that in mind, the yield of over 2 per cent on offer from the US 10-year bond seems quite attractive.
There may well be equities available with a higher yield, and we may well be entering a rate-rising period in the US. But with growth still uninspiring, and yields on European and Japanese debt even lower, the US bond market offers some relative and absolute value.