So, is there anything distinct and new that has caused market confidence to crumble? Not obviously. Rather it seems that an amalgamation of worry has simply become too heavy. The resulting turbulence may have been exacerbated by less liquidity in markets than was historically the case, and more concentrated investor positioning.
It is fair to say that markets have become more concerned about global growth prospects. We had been concerned for some time that economists were becoming too optimistic about the growth potential of key economies and that there was a strong likelihood that Europe, in particular, would undershoot expectations.
Performance of indices since 1 Sep 2014
Source: FE Analytics
The issue is that when commentators discuss returning to normal, they have in mind returning to growth rates that were averaged over five or more years prior to the 2008 financial crisis and recession. Our analysis has suggested that a return to such growth rates is neither likely nor desirable (except in short bursts).
That being the case, what might appear like minor oscillations around a mean when an economy is growing at 3 per cent plus become much more threatening when the average is lower.
Dipping a percent or more below an average growth rate of 2 per cent has more ominous and potentially damaging implications.
So, it is unsurprising that problems in the eurozone are leading to concern that it might be facing another recession. The euro is a slowly tightening monetary noose on countries that are less competitive.
The problem is very simple: if a country is trying to compete with Germany but cannot match German productivity improvements, then to stay competitive, it has to reduce costs – those costs being wages.
This is a permanently deflationary environment (deflation being falling real incomes, not falling prices).
A prerequisite for such countries to be able to match German efficiency gains is structural reform in labour markets, but this will be an arduous and by no means quick task. So, it would seem likely that the eurozone is set for an extended period of sub-par growth.
Against this backdrop, Germany is also decelerating, with its growth being inhibited by weak export markets, not just in Europe but also in Asia.
A partial solution for Germany would be to stimulate domestic demand; just how is another matter.
Markets may also be developing scepticism over the likelihood that the latest European Central Bank (ECB) policy initiatives will be game changing – rightly so, in my view.
It is not clear that targeted longer-term refinancing operations (TLTROs) will reinvigorate activity and there is more than a suspicion that the ECB has taken its latest steps more because it needs to be seen to be doing something.
And for markets, the possibility that the crisis in Greece might be about to resurface just adds to tension. The UK and US economies have developed more momentum.
While the US cannot ignore what is happening in the rest of the world, it has always been more inwardly focused as an economy. More to the point, the recent development of shale oil and gas is protecting its trade balance from what could otherwise be a nasty deterioration, consequent on demand in its own economy expanding faster than that elsewhere.
This can be likened to the boost given to the UK economy in the late ’70s and ’80s, following the discovery and exploitation of North Sea oil and gas. As a result, the US, an economy always good at post-crisis renewal, probably has the best growth outlook.
The UK’s situation is more fragile. While it, also, has developed better growth momentum than elsewhere, the trade accounts are beginning to show the strain.
Having said that, we expect the economy to grow by around 2.75 per cent in 2015.
More secure growth in both the US and UK has forced markets to face up to the prospect of policy tightening.
Given recent developments and the fact that central banks are looking for excuses not to raise rates (wrongly, in my view), an imminent increase in rates seems unlikely.
While the UK could start the process of policy normalisation as early as February next year, lower inflation is making a delay until later in the second half increasingly probable. Similarly the Fed seems likely to delay until later in 2015.
As markets begin to contemplate policy decoupling, currency markets are moving and it is unsurprising that the dollar and sterling are outpacing the euro and other currencies – a development that we had expected to see much earlier.
There are also worries about growth in Japan, where it is far from clear that ‘Abenomics’ has changed significantly the profile of an economy that has suffered two lost decades.
Meanwhile, developing economies, including China, are having to face up to the implications of weaker growth in the West. The effects can be seen in both the Asian manufacturers and, even more obviously, the commodity producing nations.
Falling commodity prices are not unhelpful to Western economies. Just as rising commodity prices acted like a tax on Western demand during the early part of the recovery period, so falling prices should allow for stronger real growth.
However, markets are seeing recent commodity price falls as further evidence that the world is in a deflationary (rather than dis-inflationary) phase.
We have not been surprised to see commodity prices fall. Matched against increased supply capacity, it seemed to us that slower growth in demand was likely to lead to a potentially long phase of softer prices.
As ever, the adjustment tends to be more abrupt than ever you would tend to forecast.
Added to concerns over the health of the world economy, markets are also worrying about geo-political developments and geo-health issues. In many ways, it might be considered surprising that there had not been greater and earlier reaction to the crisis in the Ukraine and the deteriorating situation in the Middle East.
Most obviously, both gold and oil prices might have been expected to be stronger. This helps reinforce the view that markets are not currently reacting to a single specific worry, but, rather, are sagging under an increasing pile of concerns.
The situation in bond markets is particularly interesting. While a decline in yields might seem the appropriate response to the possibility that the world is facing a significant growth pause (if not something worse), it is counter-intuitive if the worry is over the Fed’s quantitative easing (QE) programme coming to a close.
Longer-term bonds in the major government markets (and investment grade credit) are terrible value, unless you believe the world is facing outright and prolonged recession (which I do not).
Central banks have encouraged mispricing in bond markets. This is not a by-product of monetary policy, but, rather, a very deliberate policy intention.
Some central bankers have begun to express concern that liquidity risk is not sufficiently reflected in bond and credit prices, but the widespread view is that exceptionally low long-term yields are a good thing.
I am concerned that the adjustment process towards more normal yield levels, when it starts, will be painful and potentially abrupt, with very one-sided markets emerging.
QE also had an impact on equity markets, encouraging them to anticipate future growth in corporate profits to a greater degree than normal. Hence, 2012 and 2013 showed good returns from equities.
But the further into the future markets look, the more vulnerable they become to potential disappointment. The financial crisis is not yet far enough back in market history for confidence not to prove fragile when tested.
Sometimes, when markets fall, you get to a ‘no-brainer’ moment, when you can afford to ignore short-term concerns and take advantage of sudden decline in prices.
This is not such a moment for equities. Markets are not cheap and could fall further. Indeed, although we might expect it to remain so, the US market looks quite expensive.
UK equities are more attractively priced on a medium-term view, with significant value now showing through in some areas.
If you believe growth worries are being over-stated, for instance, considerable value is coming through in industrial cyclicals.
A safer way to take advantage of the value revealed by recent market declines is to focus on dividend yield and growth.
On a historical basis, the FTSE All-Share Index is yielding 3.5 per cent and the FTSE 100 is on 3.75 per cent.
These are both higher than the average yields over the past 20 years, and are particularly attractive when compared to the returns from bonds, credit or cash.
Richard Jeffrey is chief investment officer at Cazenove Capital Management. The views expressed above are his own.
