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Looking past the gloom
Equities are in a spin as the Fed's unexpectedly hawkish turn and trade disputes weigh on investors. But fears of a bear market are overblown.
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Equity markets worldwide are in retreat. The US’s tech-heavy Nasdaq index suffered its worst daily sell-off in seven years on October 10, falling more than 4 per cent, while the S&P 500 Index endured a five-day losing streak.
Investors looking for what is behind the market wobble are spoilt for choice.
One culprit is the US Federal Reserve. Earlier this month, Fed chairman Jay Powell took markets by surprise with a warning that US interest rates were still “a long way” from what the central bank considers ‘neutral’. Bonds duly fell – the yield on the 10-year US Treasury note is almost 20 basis points higher than before the Fed chair’s hawkish turn.
At the same time, there are signs that the trade dispute between China and the US is beginning to weigh on the world economy. Not only have global indices of manufacturing activity recently declined to a two-year low, but there has also been a spike in the number of companies cutting profit forecasts. The ratio of earnings upgrades to downgrades is now at minus 17 per cent, the lowest since the middle of 2016.
Add into the mix an inflation-fuelling rise in oil prices and investors could be forgiven for thinking that equities could be about to enter a bear market.
To us, that looks unlikely.
Our models paint a more encouraging picture, at least over the medium term. Compared with January 2018, when markets were last threatening to enter a protracted nosedive, the fundamental and technical indicators we monitor are more positive now than they were then.
Growth may be easing, but economic conditions remain healthy. What is more, stock market valuations are much lower now than they were in January - the forward price-earnings ratio for companies in the MSCI All Country World Equity index is 14 compared with almost 17 at the beginning of 2018. Another positive is investor positioning. Our analysis shows investors have not been excessively bullish on equities in the lead-up to this sell-off – the opposite was true in January. This suggests the scope for a deeper sell-off is limited. Finally, our technical analysis suggests the S&P 500 Index is within 2-3 per cent of a level that has previously served as a floor.
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