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Was that it or are we heading for a bear market?

Opinion is very much split within the industry about whether the recent market falls were a blood-letting correction, or the start of something a little more sinister.

Alex Paget

By Alex Paget, News Editor, FE Trustnet
Tuesday September 08, 2015

Data suggests a snap-rally is on the cards for equity markets, according to Hawksmoor’s Jim Wood-Smith, while others warn that the recent falls are a precursor to a more drawn out bear market for risk assets.

Following stellar gains for most equity markets since the end of the previous financial crisis, this year has been characterised by sharp declines across the asset class.

The MSCI AC World index, for instance, has fallen some 15 per cent since its peak in April thanks to various concerns such as stretched valuations, spikes in government bond yields, the Greek debt negotiations and huge falls in commodity prices.

Worrying data out of China, which has witnessed huge stock market losses, has been the main source of concern for investors over recent weeks though – as fears of a ‘hard-landing’ in its economy have intensified. Indeed, China’s woes were the catalyst for the miserable events of ‘Black Monday’, which turned out to be one of the worst days for markets since the financial crisis.

Performance of index since April 2015

 

Source: FE Analytics

Though fears still persist over a China-induced financial Armageddon, Wood-Smith – head of research at the group – says those concerns are hugely overblown. While he says the recent sell-off was probably needed to recalibrate valuations, he points to recent surveys which suggest that a snap-rally is on the cards.

“Morgan Stanley’s excellent strategy team has said that all its bullish indicators are flashing green for the first time since March 2009,” Wood-Smith (pictured) said.

“Their record of calling both tops and bottoms in markets is as good as anyone’s and they have given a strong message. Supporting this, the Investors’ Intelligence Survey has notched its lowest level of bullishness since, by coincidence, March 2009.”

“Now that is also interesting. Both of these could be quickly reversed by a 10 per cent-ish recovery, but the message that both are giving is that we are either at or very close to the nadir of this summer’s market tantrum”.

He added: “The markets and I have empathised. We both needed a good blow off after a prolonged period of calm. Now I hope we can all get over it and get back to business as usual.”


 

In terms of the UK equity market, the last time there were falls this large a strong rally followed.

FE data shows the FTSE All Share fell more than 17 per cent between June 2011 and October 2011 as the European sovereign debt crisis intensified and China showed signs of slowing. However, between the end of that sell-off and up to the most recent falls, the index went on to deliver gains of 70 per cent.

Performance of index since July 2011

 

Source: FE Analytics

However, there were a number of reasons for that rally which are unlikely to happen again this time around such as huge quantitative easing programmes in the US and the UK.

Given that the bull market has been going on for such a long period of time though, valuations remain relatively high and as deflation remains a threat to the global economy thanks to recent events in China, others warn that the recent sell-off could be a precursor to more prolonged bear market in equities.

One of whom is James Sullivan, manager at Coram Asset Management, who recently told FE Trustnet that the current market reminds him of the last financial crisis.

“The volatility is reminiscent of 2008. However, the difference today versus 2008 is the lack of true defensive assets available other than cash. Historically, volatility proves to be somewhat self-fulfilling so it may continue,” Sullivan said.

“Without wishing to be alarmist, in previous bear markets we have witnessed bumps in the road that were just the precursor for much greater moves – and we can't be sure this isn't history repeating.”

Performance of indices during the global financial crisis

 

Source: FE Analytics

Peter Elston, chief investment officer at Seneca, sits in between the two camps.

“What do the sharp falls in equity markets across the world portend?” Elston said.


 

“Were they simply the inevitable result of prices that had gone up too much in recent months or do they reflect significantly overvalued markets in combination with some sort of material deterioration in the underlying fundamentals?”

“Of course there is also a third option to consider: that economic fundamentals will deteriorate as a direct result of the recent sharp falls in equity markets, the so-called negative wealth effect.”

In terms of valuations, Elston says that nothing suggests investors need to be particularly alarmed about. He points out that yields are still attractive (the FTSE All Share currently 3.6 per cent) while at the same time price to book ratios are not stretched either.

Secondly, in regards to the economic picture, he notes that growth in China is certainly slowing and its economic model needs to change – which could have a knock-on effect to other parts of the world.

However, at the same time, he says recent events have pushed back the likelihood of a rate hike in the US which is likely to be a supportive feature.

As for the third option, though (that turmoil in equity markets causes an economic slowdown) he says it is much harder to predict.

“The global economy is a complex system which can often behave non-linearly,” Elston said.

“Although there will be positive feedback loops that cause household and business confidence to be impacted by the recent equity market falls, there are also negative feedback loops that can cause equity markets to bounce back. Examples of this would be government or central bank stimulus measures or people buying because prices are cheaper.”

He added: “In summary, it is impossible to say with certainty that we are not about to enter a bear market but from a business cycle and valuation perspective, economies and markets are to varying degrees some way from the point at which bear markets generally begin.”

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