It was about time for equity investors to be shaken out of their low volatility, bullish market state of existence.
The excitement started when global equities, having risen by about 50 percent in the past two years, lost eight percent of their value in a week. At the same time, volatility rose sharply (after having set record lows), with rumors of volatility sellers being wiped out circulating with alarming consistency.
This publication has noted many times that a pullback of some short was to be expected. The hope here is that readers bought protection, which also was recommended. Keep in mind that this market pullback presents a buying opportunity, as has been noted in all our publications these past three weeks.
It’s also been noted that the main fuel for the equity markets this past year and maybe next will be global economic growth. Last month we pointed out that the unemployment rate in advanced economies, as a whole, is below six percent–the lowest in ten years.
Furthermore, global economic growth continues to be respectable and broad based, with only a few laggards. Global fixed investments steadily recovered with emerging economies leading the way. The current selloff hasn’t changed this, and the synchronization of this economic growth remains intact.
A lot of ideas were put forward (mostly from perma-bears) to explain the selloff. As a result, you probably heard the usual reasons voiced. Even non-investors started talking about the “threat of inflation” and other macro-economic unbalances that the markets were preparing to expose.
What has been forgotten while the bear narrative spread is that the global economy is strong and a more regular business cycle should be expected.
It isn’t a surprise, therefore, that central banks seem poised to either continue the tightening process or embark on one. Either way, the tide has changed when it comes to monetary policy. Expect the Fed to raise policy rates next month.
Economic activity indicators remain respectably upbeat around the world. As the global economy continues to expand, inflation will gradually return, as it should. So long that major macroeconomic imbalances do not suddenly appear, the global markets will perform well this year.
True, no one can predict the future. And recognizing a market correction from the start of a bear market is notoriously difficult. Nevertheless, the indicators our team uses don’t signal serious issues with the global economy and markets. This is why, again, we view the current situation as a buyable equity market pullback.
That said, a major geopolitical event or many simultaneous minor ones could derail the markets. Although this is always the case, there are a lot of candidates these days, especially as traditional global political and economic leaders seem unwilling or unable to guide the global political process.
This state of affairs leaves a vacuum that’s being filled with an assortment of opportunists. It’s likely that this will lead to certain unsustainable situations around the world. The handling of these issues will affect global markets much more than the microscopic inflation increase in the US or at other developed economic blocks.
If investors think global economic growth is weaker than described they should sell it. However, if you agree with our thinking, this market pullback has to be bought.
On the asset allocation front, we prefer equities. In particular, stocks with strong growth and momentum characteristics will outperform in the next twelve months.
If anything, the recent spike in volatility is giving a strong boost to stocks. Especially in Europe, stocks perform well after a sharp increase in volatility, provided that this is not followed by a macro shock.
With this in mind, Europe and Asia should be the preferred investment geographies, as their earnings cycle is still on an uptrend and valuations remain reasonable. Keep in mind that emerging markets can also be viewed as a call option to global growth, with Asia being our favorite–a view that hasn’t changed during the past sixteen years.
Yiannis G. Mostrous contributes his expertise in emerging markets and international equities to Capitalist Times in his Global Top Cat columns.