Invesco Perpetual: Why there’s no need to fear a severe market correction
24 July 2014
A number of managers at the group including FE Alpha Manager Mark Barnett are cautiously positioned, but its chief economist has shrugged off fears that we are in the midst of another credit bubble.
Greenwood (pictured) think that the global recovery is far from in full swing, but says that strong stock market performance isn’t necessarily dependant on booming employment and low levels of debt.
Indeed, he says that the slow pace of recovery is supportive of asset prices.
“In the financial markets there is a recurrent debate about the apparent disconnect between high bond and equity prices and the contrast with weak global economic activity. In my view this reflects two broad misunderstandings,” he argued.
“First, asset prices are driven primarily by the business cycle, with monetary conditions at the forefront. Currently near-zero central bank interest rates have been effective in promoting equity and other risk asset prices, but, have not yet been effective in ensuring repair of private sector balance sheets or restoring normal growth.”
“On this basis it will be a long time – perhaps several years – before the business cycle and asset prices peak.”
Performance of indices since Mar 2009
Source: FE Analytics
“Second, financial markets are principally reflecting the favourable effect on long duration assets of abnormally low short-term interest rates.”
“As normality returns to household and bank balance sheets enabling growth to resume, higher short-term interest rates will be counter-balanced by stronger economic activity underpinned by recovering wage and profit growth.”
“In other words, a P/E [price-to-earnings] or multiple-driven equity market will give way to an earnings-driven environment.”
The vast majority of equity markets have more than doubled since the depths of March 2009.
The flat performance of markets over the past year or so and record low levels of volatility have prompted many to take profits and sit on cash.
However, Greenwood expects equities to carry on grinding upwards, most probably edging the FTSE to an all-time high and the S&P to a fresh record high.
“Naturally there are risks in such an outlook, but low money and credit growth provide some assurance that we are not in the same environment as in 2005-07 when rapid credit growth and high leverage made balance sheets acutely vulnerable to any adverse shocks,” he said.
“In short, this is not a financial bubble of the kind that occurred before the financial crisis. On the contrary, a key feature of the current environment is the gradual healing of household and financial sector balance sheets, to be followed later by the healing of public sector balance sheets.”
Thanks to the slow growth of money and credit, Greenwood expects inflation to stay lower for a longer period of time than in previous business cycle upswings. This, he argues, will mean interest rates can be kept low.
“A more gradual profile for interest rate hikes is expected to at least partially insulate longer duration risk assets from downward shocks,” he said.
“In short, continued moderate GDP growth implies that larger exposures to risk assets may be warranted for several years ahead.”
Aberdeen’s Bruce Stout (pictured), who heads up the Murray International trust, remains unconvinced however, and thinks risk assets are due a correction.
His bearish stance contributed to calendar year underperformance last year for the first time in over a decade, but he’s sticking to his guns, insisting that capital preservation is all investors should be focusing on right now.
“With the first six months of 2014 witnessing positive financial returns from virtually all asset classes – global equities, emerging market equities, sovereign bonds, emerging market bonds, gold, property and most alternatives – investors have become noticeably complacent in the current environment,” he said.
Performance of sectors and index in first 6 months of 2014
Source: FE Analytics
“Levels of market volatility close to historical lows suggest any negative surprises would prove extremely unwelcome under prevailing circumstances.”
Murray fears that central banks are merely making the situation worse, and thinks an even more vicious sell-off could occur as a result.
“Against a backdrop of fragile consumer confidence and deflationary pressures, the yearning for some form of economic normality gathers momentum,” he said.
“Unfortunately grossly extended debt levels, negative real interest rates, declining real incomes and anaemic economic growth suggest re-establishing “normal” economic relationships in the developed world remain no more than a pipedream for current policymakers.”
“It is becoming increasingly clear, particularly to the political establishment in the US,that the misguided experiment of QE has failed to re-invigorate growth and ease the debt burden as intended.”
“Unfortunately frustrated policymakers look set to compound misjudgements if increasingly discussed rhetoric of direct government activism becomes the next perceived panacea for sovereign debt reduction.”
“Capital preservation against such a difficult and complacent backdrop remains the prevailing investment objective.”
Stout favours defensive companies with strong balance sheets, which tend to hold up better during times of market stress.
His trust remains fully invested however, as he doesn’t actively manage cash, Due to concerns over valuations, he has more of a skew to emerging markets as opposed to developed markets.
This has helped his trust perform strongly since February of this year, putting it ahead of its IT Global Equity Income sector.
Performance of trust and sector in 2014
Source: FE Analytics
What do you think? Are we heading for a market correction, or is the current flat market a minor blip in a bull market? Let us know in the comments section below.
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