Investors should expect a near term correction in global equities without a longer term 2007-style crash, according to Stephanie Flanders, chief market strategist at JP Morgan Asset Management, who says the historical hallmarks of 20 per cent or higher equity market crashes are not in place.
Bearishness has been broadly ramping up in the past few months after a strong start to the year for equities in both developed and emerging markets.
Frothiness in Chinese stocks followed by a huge plunge and an ongoing woes over a ‘Grexit’ have made many investors consider shoring up their recent losses and hiking up cash.
Performance of index over 1yr
Source: FE Analytics
Also, since China’s A Shares collapsed, the memories of larger historic falls are in greater focus closer to home but Flanders believes several key drivers of a crash are absent from the current market environment.
“We are finding intermediaries, financial advisers, increasingly talking about the possibility of a crash with their clients,” Flanders said.
“But if you look at different asset classes and where they are in the cycle and ask are we on the verge of that kind of crisis now, it doesn’t feel like we have that kind of stress at the moment [as seen in previous crashes] and that we will not see it in the next year.”
“It is not just a case of ‘it has been a long time since we had a bear market, therefore we are going to have a bear market’. However, a correction is perfectly likely - something around 10 per cent decline.”
Flanders looked at data from the past 10 stock market crashes of more than 20 per cent decline, starting with 1929 crash right through to the recent global financial crisis.
“We asked what was going on at that time and what were the triggers and features of the environment that helped produce it. In almost every case you needed a recession i.e the business cycle to push you into a bear market.”
“In general you needed a recession that often had gone along with a commodity spike - such as the oil price in the 1970s and/or a big increase in interest rates by the Federal Reserve. Are we in a world where we are likely to have recession? That is the most important question you have to ask when thinking about whether we are likely to have big bear market.”
Performance of oil over 1 year
Source: FE Analytics
“Aggressive Fed tightening is what normally causes a recession, most of the previous recessions were caused by central banks clamping on the brakes and taking risk from the economy because they trying to get inflation out of the system.”
Interest rate hikes do look set to occur in the US and UK over the coming 12 months. Many experts are questioning whether this will be a robust or gentle move to higher interest rates, but Flanders says it is less likely to be aggressive enough to prompt a recession as inflation is at a historically low rate.
“Does it feel like we are going to have that type of recession in the rest year and a half - the central banks dramatically raising interest rates to get inflation out of the system and overdoing it? It doesn't feel like that is where we are, given where inflation is.”
“However, there is another reason you can have a recession and that is the bursting of a financial bubble. We saw that in 2007. You had the same thing in 1929 also. These are pretty unusual but honestly we are more in that kind of world - it feels more like the kind of recession that we would have relative to the high inflation scenario.”
“Just the fact that you have quite extreme valuations and the market is expensive by historical measures is not very good a predicting whether you are about to have a bear market. The only case where valuations played quite a big role in the bear market that followed was the tech bubble in 2000 where valuations got much, much higher than they are now.”
Over the past three months the majority of equity funds in different sectors in the investment Association universe are down – as are most bond funds. The exception is the UK equity space where just over half of funds across the IA UK All Companies, Smaller Companies and Equity Income sectors have posted a positive return despite their relatively high valuations.
In particular, this has been led by smaller and mid cap focused funds such as the £60m Miton Undervalued Assets fund which has posted the a return of 12.52 per cent over three months thanks to its deep value style and stock picking of lead manager George Godber and deputy Georgina Hamilton.
Performance of fund, sector and index in 2015
Source: FE Analytics
The pair have managed the fund since the start of the year since which they have returned 20.59 per cent.
