A correction of 10 per cent or more in global equity markets is looming but investors should be positioned to take advantage of any volatility, according to Fidelity’s Jeff Hochman, who does not foresee a prolonged bear market in the asset class.
Over the past six years or so, investors have been paid for taking risk as equity markets have delivered stellar gains on the back of bombed-out valuations and oodles of central bank support via quantitative easing programmes and ultra-low interest rates.
However, given it has been a prolonged period of time since markets fell considerably, many are positioning for a significant correction within their portfolios.
Hochman, director of technical research at Fidelity, agrees that a sell-off is on the cards. Nevertheless, he says investors shouldn’t fear such an event as he expects equities to deliver stellar gains again over the medium term.
“In time, interest rates are going to rise [and] bond investors are going to get hurt but over the next three to five years equities are going to perform extremely well,” Hochman said.
“I think the longer term picture is still very positive for equities and I do not expect a bear market that we have seen previously. At some point, we are going to have a correction and it’s going to be more than 10 per cent. Though we are not there yet, that is going to be a correction we will be buying into rather than selling into.”
“That’s the important thing, [a sell-off] is not likely to continue so investors should take advantage of the lower prices and volatility when we get it because markets, more often than that, rise subsequently.”
There are a number who disagree with Hochman though and one of the most notable industry experts is FE Alpha Manager Crispin Odey. 
He recently wrote that a major bear market was on the horizon and that equities “will get devastated” as despite central bankers’ best efforts, economic growth is not sustainable.
“This down cycle is likely to be remembered in a 100 years, when we hope it won’t be rated for ‘how good it looks for its age’. Sadly this down cycle will cause a great deal of damage, precisely because it will happen despite the efforts of the central banks to thwart it,” Odey (pictured) said.
According to FE Analytics, the MSCI World index has returned a whopping 166.29 per cent since it bottomed after the financial crash in March 2009.
Performance of indices since Mar 2009
Source: FE Analytics
As the graph above shows, it has moved in a largely upward trend over that time as the biggest fall (16.82 per cent) came between July and August 2011 when the European sovereign debt crisis intensified.
Hochman says the likely driver of the next sell-off will be a hike in interest rates in the US. Though economic data in the US has been far weaker than expected this year, Hochman firmly believes – like several commentators – that the US Federal Reserve will push up rates before 2016.
He says that this is likely to cause a “knee-jerk” reaction within the investor community, even though it has been well-flagged up, and could lead to a sell-off of up to 20 per cent. However, he thinks this will present a huge buying opportunity.
“It is fairly obvious now, with Janet Yellen’s comments this past week, that the Fed is looking to raise rates in 2015. The market has gone back and forth because of the data but the Fed has recently shown its cards and hence my best guess is that they raise rates sooner rather than later,” he said.
“Looking at the past 13 cycles of rate hikes, on average the market has continued to climb and rise really up until the period when they have raised rates. Subsequently, the market has consolidated, corrected, bounced back strongly and then gyrated sideways for about six months or so before resuming its rally.”
“Yes, we are likely to see a bit more volatility and possibly a correction of more than 10 per cent or even 20 per cent – but the main message is that should be bought because the market tends to come back.”
“That is easily interpreted as, usually, the Fed only raises rates when the economy is improving, inflation expectations are starting to rise and wage growth improves.”
FE data shows that in the two years following the Fed’s last five rate hikes – April 1988, February 1994, April 1997, July 1999 and June 2004 – the S&P 500 has, on average, delivered gains of 39.6 per cent.
One of best examples, and one which fits Hochman’s argument perfectly, was in 1994 when the Fed unexpectedly tightened monetary policy. As the graph below shows, the index fell initially, rebounded and then traded sideways before bouncing back strongly.
Performance of index between Feb 1994 and Feb 1996
Source: FE Analytics
Of course, many experts say that the current market is completely different to any that investors have been presented in the past given the unprecedented amounts of central bank intervention and the distorting effect it has had on asset prices.
While Hochman is positive, he isn’t getting carried away and says there are a number of caveats to his argument.
“There are some warnings signs and things we need to watch out for. From a fundamental perspective, the big issue over the last few years has been a lack of earnings growth.”
“P/E’s have gone from high single digits in 2011 to where we are now on high double digits. One could say most equity markets are fair value, but none – except for a few emerging markets – can be seen as cheap at the moment.”
“As long as inflation stays low P/E multiples have tended to expand and that is exactly what has happened over recent years. However, I doubt that multiples will be able to expand much more.”
Nevertheless, despite concerns out underlying valuations, Hochman says investors can afford to be positive as a result of the latest AAII US Investor Survey which showed that levels of bullishness in markets is down at very low levels.
He points out that “mania” normally precedes a prolonged bear market and given there are currently a distinct lack of bulls, a severe fall in equities isn’t likely.
“You can often use [the survey] as an indicator. Recently though, the percentage of bulls is down to an extremely low level – sub 20 per cent. Very, very rarely have we seen a bear market start when the percentage of bulls gets down to that level.”
He added: “It just highlights the fact that investors haven’t shown their cards as they are not quite sure what to do at the moment – and I take that as a positive.”
