Current market wobble is almost inevitable - City Comment
30 January 2014
Over the last week large cap equities in the UK have fallen by 5%. Smaller stocks and many overseas markets experienced similar declines. Unsurprisingly during the sell-off, the large cap staffing shares fell, such as: Adecco down 4%, Manpower 8% and Randstad 5%. Indeed, they had already started to experience share price declines before 21 January.
Thu, 30 Jan 2013 | By Adrian Kearsey, equity analyst at Hardman & Co
Over the last week large cap equities in the UK have fallen by 5%. Smaller stocks and many overseas markets experienced similar declines. Unsurprisingly during the sell-off, the large cap staffing shares fell, such as: Adecco down 4%, Manpower 8% and Randstad 5%. Indeed, they had already started to experience share price declines before 21 January.
So why are equity markets undergoing this mini-correction? Significant media commentary has focused on a specific number of macro factors that ‘triggered’ the sell-off. Firstly, the Fed [US Federal Bank] announced last month that it planned to start lifting its foot of the accelerator and reduce the level of liquidity it was pumping into the financial system.
Elsewhere, considerable weight was placed on economic data coming out of China. Notably on 23 January the ‘HSBC China Manufacturing PMI’ survey, surprised on the downside. Coming in at 49.6, the survey indicated a contraction in activity and was sitting at a six-month low. Finally, declines in certain emerging market currencies (notably the Argentinian peso and the Turkish lira) have prompted fears of contagion similar to that experienced in 1997 when the financial collapse of the Thai baht led to crisis across the region.
However, given the performance of equity markets since 2009, market wobbles are almost guaranteed. In the UK large cap equities gained 14% during 2013. Since their low point in March 2009 they are up 91%. Smaller companies have also performed well. For example, the AIM market is up 116% from its low in January 2009. US markets have been even stronger. For example, the S&P 500 is up over 200% from its 2009 trough. Admittedly this five-year winning streak follows one of the most pronounced bear markets of all time. But investors (even like the best sportsmen) eventually need to pause for breath.
Across a number of markets equity valuations have become quite full. A report by Goldman Sachs (‘Within Sight of the Summit’, published January 2014) recommended investors retain “their full strategic allocation to US equities”. However, the report recognised that US equities were sitting on a 23% premium to their historical average price earnings ratio. They went on the show that five-year annualised forward returns averaged 5% when valuations had reached those levels prevailing at the beginning of 2014. This compares to 7% for average five-year annualised return. Moreover, analysis shows that at prevailing valuations, equity returns were negative 37% of the time. In other words, if you had invested into the market at the beginning of January 2014, there was a “more than one-in-three chance” of you losing money (on a five-year view). Not brilliant odds.
Given the correction should investors rush into equities? Possibly. But declines could continue for a while. Moreover, as we have said for some time, we prefer being more selective and pick stocks with low price earnings multiples and/or exposure to countries where the macro environment is on an upward trend (eg. UK and Europe). It is a stock pickers market.
Over the last week large cap equities in the UK have fallen by 5%. Smaller stocks and many overseas markets experienced similar declines. Unsurprisingly during the sell-off, the large cap staffing shares fell, such as: Adecco down 4%, Manpower 8% and Randstad 5%. Indeed, they had already started to experience share price declines before 21 January.
So why are equity markets undergoing this mini-correction? Significant media commentary has focused on a specific number of macro factors that ‘triggered’ the sell-off. Firstly, the Fed [US Federal Bank] announced last month that it planned to start lifting its foot of the accelerator and reduce the level of liquidity it was pumping into the financial system.
Elsewhere, considerable weight was placed on economic data coming out of China. Notably on 23 January the ‘HSBC China Manufacturing PMI’ survey, surprised on the downside. Coming in at 49.6, the survey indicated a contraction in activity and was sitting at a six-month low. Finally, declines in certain emerging market currencies (notably the Argentinian peso and the Turkish lira) have prompted fears of contagion similar to that experienced in 1997 when the financial collapse of the Thai baht led to crisis across the region.
However, given the performance of equity markets since 2009, market wobbles are almost guaranteed. In the UK large cap equities gained 14% during 2013. Since their low point in March 2009 they are up 91%. Smaller companies have also performed well. For example, the AIM market is up 116% from its low in January 2009. US markets have been even stronger. For example, the S&P 500 is up over 200% from its 2009 trough. Admittedly this five-year winning streak follows one of the most pronounced bear markets of all time. But investors (even like the best sportsmen) eventually need to pause for breath.
Across a number of markets equity valuations have become quite full. A report by Goldman Sachs (‘Within Sight of the Summit’, published January 2014) recommended investors retain “their full strategic allocation to US equities”. However, the report recognised that US equities were sitting on a 23% premium to their historical average price earnings ratio. They went on the show that five-year annualised forward returns averaged 5% when valuations had reached those levels prevailing at the beginning of 2014. This compares to 7% for average five-year annualised return. Moreover, analysis shows that at prevailing valuations, equity returns were negative 37% of the time. In other words, if you had invested into the market at the beginning of January 2014, there was a “more than one-in-three chance” of you losing money (on a five-year view). Not brilliant odds.
Given the correction should investors rush into equities? Possibly. But declines could continue for a while. Moreover, as we have said for some time, we prefer being more selective and pick stocks with low price earnings multiples and/or exposure to countries where the macro environment is on an upward trend (eg. UK and Europe). It is a stock pickers market.
