Commentary from Harald Egger, Chief Investment Officer Equities
The international stock markets took a dive last week after a long period of healthy growth and are now contracting. This does not bode well for the medium-term outlook. As a result of panicked reactions, all markets are oversold now and are likely to swing back in the other direction. In spite of this, conditions on the stock markets are expected to be very difficult in the coming weeks. Significant negative and positive fluctuations will be the order of the day.
Is the U.S.A. sliding into a recession?
The probability of a recession in the U.S.A. is now considerably higher, as are fears that such a recession will pull the entire global economy down with it. The analysts’ earnings projections are most likely too high in every country, we expect downward revisions across the board.
The extent and duration of these reductions is hard or even impossible to project at this point. Uncertainty is always a negative factor for the stock market, and explains the high volatility and the downward pressures.
How far could the stock markets fall?
A long-term bear market is caused by a combination of different factors:
• High valuations
• High interest rates
• Mistakes by the central banks
• Strong recession/depression
Valuation: The bear market from 2000 to 2003 was caused by the bursting of the Internet technology bubble. These stocks were excessively overvalued at the time. We are not in such a situation today. The stock markets are valued very attractively on the basis of the current profit levels, and even have room to absorb significant earnings decreases. The key is the ratio between bond yields and earnings yields. Stocks are cheap compared to bonds right now.
Interest rates/mistakes by the central banks: High interest rates or an inverted interest rate curve often precede a recession. A problem in the current management of interest rates is the failure of the central banks to take action early enough (U.S.A.) or at all. They have been focusing primarily on the high inflation rates that resulted from the doubling of the oil price last year and sharp increases in the prices of agricultural commodities.
Strong recession: A recession cannot be ruled out. But no one can pin down its extent or duration. The global economy is supported by multiple pillars. The U.S.A. is no longer the sole driver of growth. The rise of China, India and other emerging markets is bringing increased stability to the global economy. This does not mean that we will see no more declines, but their severity should be moderated (by “new consumers” in the emerging markets, high infrastructural investments in Asia, the Middle East and Russia, etc.)
Summary:
Stocks aren’t expensive right now, so we don’t expect a decline like the one we saw from 2000 to 2003. But the mistakes made by the central banks (Jean-Claude Trichet said on 23 January 2008 that the ECB remains committed to fighting inflation even after world stock markets plunged on signs the U.S. is slipping into recession), the negative corporate news flow and the likely downward revisions in earnings projections will keep the markets turbulent. We have probably seen half of the correction. A temporary rally is likely, followed by a wave of selling until the situation stabilises starting in April or May.
What is the most prudent course of action for investors right now?
We should keep in mind that we are in a downward trend that could last for some months. In light of this fact, equity fund investors should note the following:
• No panic sales. If you absolutely want to sell, wait for counter-movements, which occur in every period of contraction and can be very significant.
• Longer investment horizon. Only buy when your investment horizon is at least a couple of years. If you need the money in 6–12 months, keep away from stocks.
• Pay close attention to the fundamental data. When we slip into a recession, earnings can fall very quickly for some companies, and what seems like a cheap stock can get very expensive quickly. Investors should stick to companies with stable, non-cyclical earnings development.
• Buy in small packages. Buying is OK, but only in small steps. Don’t spend all your money at once, take advantage of temporary price drops.
