Many investors are concerned about the recent drawdown in equity markets. I must admit watching the DAX lose 12% from its highest point in June is not a pretty sight but nor is it a reason to panic and head for the exit. Here are my reasons why:
Looking back at history
If you look at the performance of the DAX Index in 2014, you will see that from its June peak the market had lost 15% before it rallied 45% till the end of the third quarter of 2015.
Every situation is different. Back in the summer of 2014 the markets were concerned with the unrest in the Middle East. Today the market is worried about a slowdown in China’s growth and a potential rate hike in the US.
Where we go from here depends on how much is priced in, depending on investors’ expectations on capital markets. My view is that the current selloff has created attractive entry points. Even by stress testing our valuation models to factor in a deteriorating global growth scenario, there continues to be value, particularly in European stocks.
Technical Analysis
Before the markets started selling off in August, technicals were flagging a sell signal. Valuations were tight after the rally in equity markets following the agreement between Greece and its creditors. It was time for valuations to get back in line after the market rallied when Europe confirmed it was not going to lose one of its members.
However, now that prices have corrected, there are companies out there which are trading at bargain levels and it would be prudent to start building positions as we head towards oversold territory.
Technicals are playing an important part in these markets. If you look at the performance of the DAX Index in 2014, you’d see that it was flat for the year. However, during the year there were at least four times when the index fell by close to 10%. Traders would have outperformed the market compared to a buy and hold investor.
China
Yes a slowdown in China is a concern to global growth. Although data is showing signs of a slowing economy, it is still not alarming. Last week we had companies like Volvo report that is it forecasting a big profit rise this year as the rebounding sales in Europe and the US are offsetting a slowdown in Chinese sales.
Just like China made up for lacklustre sales from Europe and the US in the past, now I expect sales from Europe and the US to make up for weakening sales in China.
Slowing global growth is the major concern of investors. However, the major threat is a potential rate hike in the US. A wrong policy move by the Fed could put the world’s developed nations back into recession.
A rate hike in the US
The Federal Reserve raising rates is a concern for investors. With China slowing down and Europe just starting to show positive signs of improvement, a rate hike in the US could cripple global growth and send the US and other countries back into recession.
I don’t think the Fed Chair would increase rates anytime soon especially not in the September Fed meeting.
Valuations are attractive
After the recent market correction, European equities are once again at bargain prices. I stress tested our valuation models to factor in a potential slowdown in global growth and the results continue to show potential upside in European equities.
Look beyond short term fluctuations
Don’t give too much important to short term fluctuations and look at the bigger picture. Over 1-year the DAX Index is up 10%, over 5-years it is up 70% and over 10-years it is up 110%. I am confident that equity markets will continue generating positive returns for investors.
Conclusion
Both technicals and fundamentals are showing attractive entry points in the European equity market. If you are already invested, I would stay in the market. It is not the time to be selling out.
On the other hand, if you have cash on the side line ready to enter the market, I would start building positions in both market ETFs and individual names. It is in times like these, when you pick up bargains in names that will generate attractive returns in your portfolio in years to come.
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.