The risk of a correction appeared to be troubling equity markets at the start of June. However, the combination of improving global growth, solid business conditions, rising profits and low interest rates indicate that equity valuations may still be at acceptable levels. Following the impressive positive price movement in the fifth month of the year, several analysts started questioning whether earnings could keep up with valuations.

Doubts intensified as June progressed and equity indices suffered. European equities, as gauged by the Euro Stoxx 50, fell 2.9%. The S&P 500 and the Morgan Stanley Global equity index remained largely unchanged. One of the culprits was a speech by Draghi warning that policy will need to adjust once inflation rises. But at this stage there is still little evidence of an increase in underlying inflation, and political risk around Italy will likely slow Draghi from moving too quickly.

Having said that, I am of the opinion that interest rate policy can only go in one direction from here onwards. Market benchmark yield increases will precede policy. The next significant movement in fixed income yields will probably be around September when the ECB meets after the summer recess. In the meantime, daily news will determine short-term movements.

The general view is that the ECB it will announce a 2018 taper to its quantitative easing program later this year, but that rate hikes are a while away. Moreover, the Bank of Japan remains years away from any easy money exit and the US Federal Reserve provided no surprises with its fourth rate hike this cycle, no change to the so-called dot plot path for expected future interest rate hikes.

The other culprit was a 12% drop in the price of oil by mid-June. The oil price has been trending down since February amid concerns that rising non-OPEC production will offset OPEC production cuts. The weak oil price highlights the broader lack of inflationary pressure globally which will keep pressure on low interest rates.

I am of the view that equity markets tend to move in the opposite direction of yields. Yields increase because market players reduce fixed income holdings in anticipation of increasing rates. The liquidity may be channelled into riskier assets, such as equity markets and high yield bonds; if investors perceive that the economy is strong enough to sustain positive growth.

The investment manager expects some turbulence over the coming weeks as mixed economic data, rich market valuations and profit taking hit market confidence. It is also the holiday period, and several important players may be on holiday; this effects trading volumes and liquidity.

The equity earnings season should shed some light on the trend for the rest of 2017. Small corrections during this period may be viewed as opportunities to invest into the equity market for investors that have been reluctant to dip into the equity market to date.

 
This article was issued by Antoine Briffa, 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