Sentiment towards equities is now as low as it was during the depths of the European sovereign debt crisis, according to the Fidelity Composite Sentiment Indicator, and Kevin O’Nolan says this has provided a decent buying opportunity for investors.
Appetite for risk assets has been falling throughout 2015, following six or so years of near uninterrupted gains from the likes of developed world equities.
Though many stock markets reached their historic highs during the first few months of the year, macroeconomic headwinds such as high valuations, falling commodity prices, spikes in bond yields and the Greek debt negotiations have meant indices have been falling since April.
Those losses were compounded during the month of August though, as worrying developments out of China sparked an indiscriminate sell-off across global financial markets – the worst of which occurred on 24 August which has since been dubbed ‘Black Monday’.
Performance of indices since April 2015
Source: FE Analytics
While markets have shown some sort of recovery since then, many experts warn that the huge price swings that have occurred over recent weeks are very similar to the backdrop presented to investors prior to the financial crisis – suggesting therefore that a much nastier equity market crash is on the cards.
O’Nolan, who heads up a variety of multi-asset funds at Fidelity with Nick Peters following Trevor Greetham’s departure from the group earlier this year, thinks much of that bearishness has been overblown.
He points out that the group’s Composite Sentiment Indicator was as low as it was during the European sovereign debt crisis in 2011 and close to its lows during the financial crisis.
Performance of indices since June 2006
Source: Fidelity
As a result, he used the weakness to top up his exposure to the equity market.
“We saw quite a lot of volatility in August with equities falling about 10 per cent from peak to trough. For me, this was a particularly acute to the weakness that has been going on in China,” O’Nolan said.
“It really started with the [China’s] announcement to move towards a more market based currency earlier in the month. That instigated quite a lot of volatility in emerging equities and that spilled into global equities.”
“Equity investor sentiment got to its lowest level since the summer of 2011 during the heights of the European crisis. This really reflects the weakness we have seen in emerging markets and concerns among market participants that it was going to spill over into developed market growth.”
“We remain confident that isn’t going to be the case. Actually, we used it as an opportunity to add to our equity exposure.”
As fears of a full-blown break-up of the eurozone plagued markets in August 2011, the FTSE All Share fell some 19 per cent until the index finally bottomed in October that year.
However, following those falls, data from FE Analytics shows the index has since gone on to gain 45 per cent up to today and had even returned close to 65 per cent until the recent correction started in April earlier this year.
Performance of index since October 2011
Source: FE Analytics
Of course, many experts believe that sort of performance is unlikely to repeat itself as much of those gains came from share price re-rating rather than strong growth. They also point out that valuations are much higher today than they were then.
Nevertheless, O’Nolan still believes the outlook is decent for risk assets – especially given that the US Federal Reserve (Fed) has decided to keep interest rates at their current rock bottom levels while inflation remains very soggy.
“Things look positive. We are constructive on developed market economic growth. Unemployment rates across all the major economies continue to fall at the same time our leading indicators are relatively neutral, which suggests growth is at a good level but not accelerating or decelerating at the moment.”
“At the same time, the inflation picture remains very benign as across all the developed and emerging markets it is at very low levels. We had seen a bit of a pick-up in momentum earlier in the year, but that has again faded over recent months.”
“The combination of good growth and low inflation is a very good environment for risk assets (equities in particular) as central banks can keep policy loose for a longer period of time.”
Hermes’ Tim Crockford agrees with O’Nolan as he has been buying into European equities following the latest sell-off.
“For us, the biggest surprise of the summer sell-off was the extent to which the market was caught off guard by China’s currency devaluation – which served as an admission that all was not fine,” Crockford said.
“For a number of years, we have been factoring in the slowdown of the China growth engine, which will negatively affect export-led companies dependent on Chinese demand, such as luxury goods manufacturers and automakers.”
“However, we have been focused on the resurgence of the domestic European economy, which is being driven by domestic consumption, taking up the slack from the decline in exports to emerging economies.”
One area O’Nolan is avoiding, however, is fixed income.
The FOMC’s announcement regarding a continuation of loose monetary policy last week caused yields on most government bonds to fall sharply, but the manager says this trend is unlikely to continue.
All told, the likes of UK gilts, US treasuries and German bunds have now managed to recover most of their losses they incurred during the spring months as investors’ appetite for risk has waned significantly.
Performance of indices in 2015
Source: FE Analytics
Nevertheless, O’Nolan says that while rates will remain low for now, they will start to rise over the coming year or so making a back-up in bond yields an inevitability.
“We are underweight bonds and property, so yield sensitive plays, and that is really reflecting the view that while the Fed didn’t move last week, we are moving closer to a normalisation in policy over the next few years.”
