Global equity markets are down -16% since 22nd July
The primary drivers have been recent events around the US debt ceiling culminating in an S&P downgrade of US debt to AA+ and on-going concerns around mainland European sovereign debt: Greece, Portugal, Spain, Italy and Ireland. Secondary has been the China slowdown, widening panic amongst financials and banks, continued riots in London, and elevated levels of market volatility last seen in 2008.
The recent S&P downgrade of US debt lacks credibility; incorrect assumptions around Bush tax cuts, a $2 trillion error based on an incorrect baseline figure, and a change to the basis of their argument from debt/GDP to political risk at the last minute.
Surprisingly, we have seen some US Treasury and USD strength, but more importantly the CHF, Gold and Yen have all become alternate safe havens. We would expect the Federal Reserve to respond to the current market turmoil; quantitative easing (QE3), interest rate cuts, and or selling short term bills and buying long term bonds. There has even been talk of central banks and sovereign wealth funds buying domestic equities.
Investors need to stay focused on fundamentals and remember that the US and some of Europe are still able to print, tax or grow their way of their current troubles. The broader issue is the risk of a double dip recession. We maintain that US policy makers will reflate and do whatever it takes in terms of monetary and fiscal policy to get investments, consumption, and the labour and housing markets back to healthier levels. In Europe the sovereign debt crisis is likely to escalate further.
Short term risks and volatility remain high but our sense is markets have become too bearish. Whilst we are cautious short term we see improving corporate earnings, fair equity valuations and low interest rates all supporting the longer term global recovery. Our sense is to watch political and market events very closely over the coming weeks and look for suitable entry points once all the dust has settled.