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Reality check on equity markets

Kristian Camenzuli, investment manager, Calamatta Cuschieri, explains the current opportunities to pick up stocks.

On August 24, 2015, equity markets suffered a shock which sent investors into panic mode. On that day the Euro Stoxx 50 fell by five per cent, a one-day correction which was compared to the five per cent drop suffered on January 23, 2008, when world equity markets witnessed a similar bloodbath. That was the start of the financial crisis that led to the eventual bankruptcy of Lehman Brothers on September 15, 2008.

However, I don’t think that we will witness another 2008 and a day like grizzly Monday is an opportunity to pick up stocks. Here is why.

European and US stock markets are not in a bubble

The sell-off in equities in the developed world was triggered by the creation of a bubble in the Chinese markets. A bubble is formed when prices are not driven higher by attractive valuations but by the greed to get rich in a short period of time.

Before the Shanghai composite entered into a correction phase, the same index was up 150 per cent in just 12 months. During the same period, the European and US markets were up 10 per cent.

As an old Wall Street saying goes, “Bulls make money, bears make money but pigs get slaughtered”.

Investors fear September

September is normally the worst month in the year for equity markets. However, the fact that is not news to investors resulted in the sell-off being pre-empted and brought forward to August.

From late September to mid-October 2014 the German DAX gave up 12 per cent of its performance. However it then rallied 45 per cent to its high in mid-April 2015.

Economic growth in the developed world

After the start of the financial crisis in 2008, the world entered into recession. In 2009, Europe reported a negative growth rate of 4.5 per cent and the US a negative growth rate of three per cent.

This is not the case today. For 2015, the European Central Bank is forecasting a growth rate of 1.4 per cent for the Eurozone and the Federal Reserve two per cent for the US with an improvement in growth in the years ahead.

Although the ECB slightly reduced its growth forecasts for the Eurozone, ECB president Mario Draghi gave a clear signal that the ECB will increase its quantitative easing programme if economic data deteriorates further.

Economic growth in China

The negativity in the markets is driven by an expected slowdown in China which is also bringing down global growth forecasts.

There is no denying that China’s economy is slowing down and it is also true that gone are the days that the Chinese economy will see growth rates above 10 per cent.

The market is worried that China won’t be able to grow its economy by seven per cent this year. However, what is also true is that People’s Bank of China has a lot of tools at its disposal to stimulate the economy and be accommodative.

If the PBOC does its part to stimulate growth in China and US and European economic growth picks up, it will be a net benefit for European and US companies.

Talk of a rate hike in the US

I don’t expect the Fed to announce a rate hike next Thursday. It is more likely to raise rates in December, giving some breathing room for equity markets. Also, I don’t think the Fed would rush to raise rates if it isn’t convinced the positive data is sustainable, especially with elections coming up next year.

Valuations are attractive

Even by factoring in lower growth rates, company valuations are attractive. With companies like BMW, Volkswagen and Allianz trading on an earnings yield above 10 per cent, I wouldn’t think twice before starting to add to positions. Days like these won’t come too often.

Volatility is here to stay

Gone are the days when a simple ‘buy and hold’ strategy is the best advice to generate positive returns. Today markets are becoming more volatile, which in itself creates opportunities.

When volatility was low, option traders made money by selling put and call options and just earned the premium. Today, with increased volatility, there is greater scope for these players to enter the market, creating greater swings in equity prices.

This is where technical analysis comes into play. Taking a strategic view and timing your entry into and out of the market will help you increase your portfolio performance.

Stay overweight in European equities

I would take advantage of sectors which have outperformed the market in times of quantitative easing. These include the auto, banks, financial services and construction industry. I would also take a position in the market in general which should continue to generate returns for shareholders. Make sure your portfolio is diversified at all times.

For your portfolio to generate positive returns you need to be convinced in what you are investing in, cut your losses and don’t get emotional about your investments. If you do this and take a five-year view, your portfolio should generate attractive returns in the years to come.

The information, views and opinions provided in this article are 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.

Calamatta Cuschieri is one of Malta’s leading financial services firms. The company offers a wide range of investment services including independent investment advice, live online trading, savings plans, investment management and fund services. For more information visit www.cc.com.mt.

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