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August 26, 2015 at 08:09 AM
The global market meltdown is turning into a rout as investors who ignored the warning signs of overvaluation, weakening earnings and revenue trends, and deteriorating internal market dynamics may now be heading for the exits. As you try to rationalize your allocation and equity market exposure, you may deem it appropriate to stick with investments in countries with the strongest economies. Reasoning, stronger eco-markets should behave better than markets in countries with economies under pressure.
The U.S. has had the strongest economic recovery so far, followed by England and Germany. These could be better bets than the Asia-Pacific and commodity-based export economies. As China ’s economy falters, fear of worldwide growth stalling is leading to market carnage and currency devaluation wars.
The velocity of declines in China, Asia and emerging markets is reminiscent of declines on Black Monday in 1987 when the Dow fell by more than 30% in two trading days. What many people don’t remember about that year is that the popular U.S. indexes bounced back by the end of the year.
We believe market conditions are ripe for further declines of 20% or more, registering a classic bear market decline. However, we would not be surprised to see the U.S. and strong eco-market equities stage a comeback by year-end, erasing a good portion of the damage. Right now, we consider U.S. Treasuries to be particularly attractive on the flight to quality trade. Bonds, much maligned on rising interest rate fears, are not dead yet and look attractive as equity valuations adjust. We believe the Fed is likely to abandon any plans for an interest rate hike cycle for quite some time.
We expect bear market declines will cause valuations to look more attractive than they have for several years which may lead investors to move back into safe haven markets. Misplaced calls for monetary authorities to tighten may fade along with hopes of improved economic growth. Outside the U.S., we expect to see additional monetary support to shore up ailing economies. We anticipate additional easing to provide a backstop for excessive market declines in Asia and emerging economies.
Macro market risks, which were being ignored by investors, are becoming quite evident. Still overlooked, we feel, is the level of government debt that has piled up as economies struggled to fight off financial contagion. Economics 101 would suggest the tremendous debt burden incurred to keep financial systems functioning is a drag on economic performance even at extremely low interest rates. It’s clear to see these effects in China, Brazil and Russia as slow world growth compresses commodity prices. In the U.S., debt levels soared by 250% to prevent the 2008 Financial Crisis turning into a depression. We believe the low 2% growth rate is a clear expression of the drag $18.5 trillion of debt is having on the economy.
