Author: NN Investment Partners
The market correction that began two weeks ago and accelerated in the past week followed a remarkably calm period that lasted almost two years. We view the recent price movements as an overdue correction triggered by a shift in market views concerning risks of inflation and central banks’ hiking paths. Sentiment has meanwhile shifted from very optimistic to neutral with a pessimistic bias.
Chief Investment Officer Valentijn van Nieuwenhuijzen and Principal Strategist Patrick Moonen discussed recent market movements in a conference call this morning. Highlights of their remarks are presented here.
We believe that this correction will not derail the current synchronised growth in the global economy, which is still the strongest it has been in many years. Equity fundamentals also remain unwaveringly strong.
The correction was largely technical in nature, with positioning levels and investor optimism indicators at multi-year highs. The correction was centred in US equities. In addition to the biggest one-day drop in US stocks since 2011, we also saw the sharpest rise ever in the VIX volatility index. Equities are meanwhile back to their levels of midway through the fourth quarter, levels that were the result of a steady 12-month climb.
Despite the recent price movements, there is no sense of market panic. Outflows were evident in the US and some emerging markets, but not in the Eurozone.
Investor concerns about inflation, rising wages and rate hikes by central banks were already evident in the rise in bond yields during recent months.
We believe the risk of overheating is quite low. We are not at a tipping point where the US Federal Reserve will accelerate its hiking, nor are they likely to become more dovish. Still, Wednesday’s US CPI data may be one of this year’s most closely watched indicators this year.
Since the beginning of the year, we had identified three main risks: inflation and the response by central banks; concentrated consensus thinking on the part of investors; and high valuations in US equities and corporate credits. We responded to these warnings signs by maintaining underweight positions in government bonds and US equities, reducing our exposure to spreads and reducing our overweight position in equities in our top-down allocation.
Equity fundamentals remain strong. The current earnings season has been very positive and expectations for 2018 have continued to rise. Earnings momentum, measured as earnings estimate upgrades vs downgrades, is at a 2-year high. Corporate fundamentals are still as good as they were at the beginning of the year.
We remain most positive on Japan and Eurozone equities. Both markets are driven by their cyclical sensitivity to global growth, equity risk premiums that are still well above historic averages, and their earlier points in the monetary cycle and more accommodative policies than the US.