Equity markets have been far too well behaved over the last few years, and it was only a matter of time before waves of turbulence returned to the mill pond. As usual, the media is buzzing with explanations of the pullback, but markets often don’t need a good reason, nor is there much to be gained from speculating about it. Market ‘corrections’ are normal, what is unusual is why we haven’t seen one for so long. In fact, the dramatic fall, while uncomfortable, is perhaps the most significant sign of health in markets for a long time.
It is worth highlighting that the global equity market is still in positive territory since the start of the year, having risen strongly in January prior to the fall.
The US market has generally been considered expensive for several years. In the recent pullback, US equities fell most sharply, whereas emerging markets held up relatively well. This is the opposite of what we expect to happen in a sustained market downturn, as emerging markets are considered most risky. This suggests therefore that the sell-off was at least in part focused on valuation, rather than due to concerns about the global economy.
As ever, we won’t gaze into the crystal ball (which we know to be permanently broken). However, at times like this, it is always wise to take stock of the wider investment environment. There is no evidence of a downturn in the economic cycle, and the outlook for global growth remains healthy. Corporate profits are rising, and corporate balance sheets are relatively strong. Inflation cannot stay low forever, but until global interest rates begin rising significantly, increasing the return on cash and other low-risk assets, there is unlikely to be a sea change in the support for quality multinational companies.
Of course, a long-term investment strategy should adjust according to market conditions, but history tells us not react to short-term noise. Turbulence often offers active managers the opportunity to find value, taking a longer-term view on the prospects for quality companies.