Download The Four Big Questions For Investors After `Black Monday

The four big questions for
investors after 'Black Monday'
meltdown
As global equity markets struggle to recover after a turbulent few days, we
take a closer look at the major issues still troubling investors.
1. Is this the start of a full-blown bear
market, or just a correction?
As markets went into free-fall on Monday, investors could have been forgiven
for fearing the worst as billions were wiped off global indices.
By mid-afternoon, the FTSE 100 had fallen 6%, although it recovered slightly to
finish 4.7% lower at 5,899. This marked the first time the blue-chip index had
sunk below the 6,000 mark since January 2013, with £96bn wiped off share
values. It was a similar picture across the globe, as the Dow fell 1,000 points on
opening, while emerging market equities and currencies were particularly badly
hit.
However, with no new economic data to justify the slump, the consensus view is
equities have suffered a correction rather than entered a bear market. Industry
commentators have highlighted that a full-blown bear market normally requires
an economic recession, and this scenario is highly unlikely for developed
markets. So what happened, and why?
According to Mark Haefele, UBS Wealth Management global chief investment
officer: "...the latest move has the hallmarks of a self-reinforcing correction driven
by quantitative risk controls setting in across hedge funds, trading books, and
dedicated quant strategies. After months of low volatility, a sudden spike has
driven up the calculated risk in many strategies as heavy losses lead to a
reduction in desired market exposure.
"Market moves compelled other investors to exit overcrowded consensus trades.
This was illustrated by heavy selling of the dollar - a popular overweight position
that has been profitable for much of the year. Gold, another safe haven asset that
would typically benefit from market angst, was also down."
The hold-steady approach taken by professional investors as stocks markets
plunged further into the red was particularly telling. While the speed and severity
of the falls surprised, many were already cautiously positioned in anticipation of
some kind of market pull-back. They clearly saw the rout as a buying opportunity,
not an inflection point which would prompt radical portfolio shifts.
2. Is China out of control?
This question may be harder for investors to answer, but what the past few
weeks have unequivocally demonstrated is the Chinese authorities have failed in
their bid to stamp their authority over equity markets. The move by the People's
Bank of China (PBOC) on Tuesday to cut the country's benchmark interest
rates also failed to provide the necessary reassurance for investors, with the
Shanghai Composite down 1.27% by the end of the following day's trading
session.
According to Carmignac managing director and member of the investment
committee Didier St-Georges, the loss of trust by global investors in the Chinese
authorities following recent events should not be underestimated, as it plays a
key role in influencing capital flows.
"Not only is their transparency very poor, but also their management of the
domestic equity market bubble has been pitiful, so has been the management of
its bursting, and later their decision and communication on the RMB," he said.
It is this lack of openness which fanned the flames of panic-selling over the past
few days, as investors' concern grew about what the Chinese authorities were
concealing on the health of the world's most powerful growth engine.
However, despite the painful exposure of the Chinese leadership's failure to
control equity markets over recent weeks, the country's political structure still has
the potential to stave off a full-blown crisis for the world's second largest
economy.
According to Neptune Investment Management CEO Robin Geffen: "China's
political economy is uniquely helpful, allowing it to bail out the financial system
before a crisis occurs (which it is doing already, and which stands in stark
contrast to Western governments).
"It also allows for strong fiscal support for the economy to be stepped up,
financed by the central bank in a rare case of ‘helicopter' money policies being
implemented."
3. Will the Fed stay its hand on raising
interest rates?
The majority of commentators agree interest rate rises are likely to be pushed
back until 2016 as the deflationary forces of lower commodity prices allow central
banks to delay the inevitable.
BlackRock chief investment strategist Ross Koesterich commented: "If the Fed
were to hike next month, this would imply a sharp spike in real interest rates (the
interest rate minus inflation), a scenario that has historically been associated with
more severe corrections for US equities."
Even before the recent sell-off, it was far from certain the Federal Reserve would
raise rates as early as September. In its minutes from the 28-29 July meeting,
the Fed saidconditions for a hike were "approaching", but there was trepidation
about firming rate policy too soon as pressures on inflation and concerns about
China weighed. Only one member voted for a hike last month.
However, contrarian voices, including Neptune, believe the Fed will stick to its
guns and raise rates this year.
"The debt imbalances within the US - which have been created as a result of
cheap government-sponsored money - are not yet excessive in absolute terms,
but they are growing quickly. The Federal Reserve will not want to delay
correcting them. We believe it will see in the US an economy with enough
fundamental strength from jobs growth and a housing recovery to allow for this,"
Neptune said.
All eyes will now be on this week's Jackson Hole meeting of central bankers for
further clues on how policymakers will respond to recent events.
4. Is now the time to take advantage of
market volatility and rebuild emerging
market positions?
Even before Black Monday, emerging markets had suffered a punishing level of
outflows (around $1trn over the past 13 months according to some estimates roughly double the amount that flooded out during the financial crisis) as tumbling
commodity prices, concerns over a China slowdown and fears over the impact of
US rate rises weighed on sentiment.
According to Matthew Merritt, head of multi-asset strategy group at Insight
Investment, emerging markets - particularly those with heavy exposure to
commodities - are undergoing an adjustment and the safety valve has been their
currencies.
"The process of adjustment in emerging markets is nasty, brutish, but ultimately
necessary. [But] given more flexible exchange rate management regimes and a
greater diversity of funding sources, particularly local currency debt, the
contagion is unlikely to be as severe or widespread as the aftermath of the Asian
currency crisis in 1997."
Commenting on emerging market and commodity volatility in recent weeks,
Valentijn van Nieuwenhuijzen, head of multi-asset at NN Investment Partners,
added: "It is noteworthy how large the consensus is, amongst active players in
the markets, to be negative on these asset classes...moreover, technically
speaking, many of these assets have now reached "over-sold" levels.
"Generally, these type of indicators can provide a contrarian signal, so a shortterm bounce from the bottom cannot be excluded in these market segments at
this point. How long these dynamics will last is also very difficult to assess; some
of the China/EM ripple effects into the underlying fundamentals can easily come
back to haunt markets in the more medium term.
"For us, current investor behaviour is actually only a reason not to increase our
underweights in the EM and commodity-sensitive areas as we keep fixed income
spreads (large EMD/US HY weight) and commodities at medium."
It is these potential ‘ripple effects' which are concerning investment groups like
Charles Stanley which is "very cautious on emerging markets, and is resisting
buying in those markets despite the attractiveness of valuations on face value".
However, other investors are identifying buying opportunities. Dan Kemp,
Morningstar Investment Management chief investment officer EMEA, said it was
"taking advantage of volatility to increase exposure to high quality assets that
have become attractively priced, including emerging market equities".