The rout is set to continue

Last week fear well and truly took over from greed, as equity markets worry a China slowdown will lead the world back into recession. It was said that when the US economy sneezed the rest of the world caught a cold, it rather appears that China has taken on that mantle. As at Friday nights close the Ftse 100 has lost 12% of its value from earlier this and the S&P 500 is closing in on a 10% correction from its highs.

 

Is this a healthy correction in a bull trend or is it the start of a more sustained downturn in equity prices after 7 years of rising equity markets? The bears will argue that valuations are high, earnings season was satisfactory but no more, and the global economy is slowing and central bankers are running out of ammunition stimulate growth. The bulls will argue, equities still offer an attractive investment case relative to other asset classes in particular, the earnings season overall was satisfactory and that companies has defended profits in a low inflation, low growth and low interest rate environment and whilst that status quo remains should continue to do so. If investor surveys are to be believed investor cash levels are high, if this is the case this too should give equities support. 

 

The “fear gauge” or Vix rose to levels last seen in summer 2011, caused on that occasion over fears that the US government credit rating was downgraded. The Vix rose 120% in the past week, the largest weekly rise in in history of the index, according to Factset data, closing the week just below 30.

 

Trying to analyse where one could suggest a floor might be is almost impossible easy as sentiment plays such an important past when equity markets correct and just as they overshoot on the upside, they can do so on the downside. Analysts are forecasting the S&P 500 companies to produce $127 per share of earnings for this year. If one put that number on a historical average multiple of 14 times, that could suggest fair value for the index would be back down to 1800 approximately, another 10% below where it is now. One has to assume the selloff is not over yet, technical analysis would probably favour the suggestion that index has broken through several support levels.

 

China will remain in focus, on Tuesday the Conference Board reports its latest index reading. The index is a composite average of 6 leading economic indicators. The index is designed to signal peaks and troughs in the business cycle.

 

As equities took a knock bond prices rose as the US ten-year treasury yield fell back to 2.05%. Two year yields, the most sensitive to interest rate sentiment changes fell sharply in both the US and the UK. This move in the stock market has probably put pay to any rise in interest rates, either over here or across the pond.

 

Equity markets in Asia overnight on Sunday extended the rout as Hong Kong’s Hang Seng index fell nearly 5%. European equities are set to open down 3-4% on Monday morning. Equity market corrections are painful; many years of gains can be lost in weeks. The long-term investor has to accept the volatility as the price of being part of an investor in this asset class, and remember that crisis always brings opportunity. 

Posted on August 24, 2015 .