Market falls: cause for alarm or calm?

Stock markets globally have been falling since the end of September. Economic worries including a potential trade war between the US and China, currency
crises in Turkey and Argentina, debt problems in Italy and rising interest rates have seen stocks globally begin to fall from record highs.

As the chart shows, since 31 August emerging market stocks are down 9.7%, world stocks have fallen 8.6% and US stocks and European shares are down 8.5% and 7.6% respectively. The best-performing index of those highlighted below is Japan's Nikkei 225, which is down 3.4%. The FTSE 100 fell 6.3%.

The VIX, also known as the “fear gauge”, is at its highest level (25.2) since 6 February 2018. It measures the expected price fluctuations in the S&P 500 index over the next 30 days.

The higher the level of the VIX, the more likely it is that investors are anticipating a market-moving event occurring in this time period.

While the retreat in stock markets has been more severe since the start of September the malaise set in at the start of the year after what had been a strong 2017.

As you can see from the table below, 2018 has generally been a tough year for stock markets.

Emerging markets have suffered the most, down 17.7% on the year to date. They hit their 2018 peak back in January around the same time as European and World stocks, which have fallen 9.2% and 5.5% respectively this year. Stocks in the UK, which is facing the prospect of Brexit in the new year, are the second worst performing in 2018, among the indexes highlighted below, with the FTSE 100 down 9.4%. Japanese stocks (Nikkei 225) are down 3.0%, while US stocks (S&P 500) are the best performing so far, down 0.7%.

Half the indices below are now in correction territory, which is when there has been a fall of 10% or more. Emerging markets are nearing a bear market, which is a fall of 20% or more.

Perhaps a barometer of investors’ concerns is the recent performance of the US’ tech-heavy NASDAQ. The index is down 12.3% from its 2018 high on 29 August 2018. It tumbled 4.4% on Thursday 24 October, its biggest one-day fall since 2011. Among the stocks listed on the NASDAQ are the highly valued “FAANG” stocks, otherwise known as Facebook, Apple, Amazon, Netflix and Google.

What’s causing the selloff?

A number of factors have combined to make some investors jittery and cause market volatility to rise. The geopolitical factors that have periodically dampened investors’ appetite for risk this year – primarily the escalating US-China trade war, but also currency crises in Argentina and Turkey and Italy’s fiscal agenda – remain ongoing.

Investors also continue to worry about how much longer the current economic cycle can last, especially with the major central banks turning less supportive.

Indeed, the US Federal Reserve has raised interest rates three times this year already (with more to come) and the European Central Bank is poised to end its quantitative easing programme.

Until recently, investors had largely been able to overlook these factors due to the strength of corporate earnings, particularly in the US. However, so far in the Q3 earnings season the picture has appeared less rosy than many expected.

Time for alarm or for opportunity?

Some equity investors may be tempted to panic-sell at such a volatile time, though history teaches us that is seldom advisable. The ensuing periods have often been rewarding to steadfast investors who are able to hold their nerve. Looking at Europe, there are reasons for investor optimism rather than alarm.

Investors shouldn’t be alarmed that the economic cycle is maturing. It’s ten years since the financial crisis and global growth has been resilient for a number of years. The natural course of events is to expect a slowdown because economies can’t grow in perpetuity.

Since the financial crisis, European equities have not recovered to the same extent as the US, for example, and valuations continue to look attractive. The super-tanker European economy should continue on a low growth trajectory for the coming year or two but we acknowledge the global backdrop looks more challenging.

As we enter a period of slower growth, identifying the most attractive companies becomes even more important for investors seeking to harness returns ahead of the market.“Markets remain susceptible to volatile periods and when we will be opportunistic and take advantage of this volatility to buy assets that become mispriced.

What’s happened to valuations?

As mentioned above, valuations have indeed become more attractive as a result of recent volatility.Price-to-earnings (P/E) ratios (one of the most widely used valuation measures) of all the major markets have come down significantly this year.

P/E is calculated by dividing a stockmarket’s value or price by the aggregate earnings per share of all the companies over the next 12 months. A low number represents better value.

Following the recent pullback in markets, we have started to increase our equity allocations. The move is tactical; we are in the mature phases of the equity bull market, but we believe we have a window of opportunity to generate returns as we head into year-end.

This is because the indicators we are monitoring are stable, and a combination of strong corporate earnings in the US and weak equity prices in the rest of the world has resulted in an improvement in equity valuations. Our cyclical indicators (ie the data we use to give us a picture of the state of the economy) suggest that are still in the “expansion phase” of the economic cycle and our recession indicators suggest that we are still at least 12-18 months from recession.

The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested.

Equity prices fluctuate daily, based on many factors including general, economic, industry or company news.