By Richard Buxton- Head of UK Equities at Schroders
Once again, equity markets are plunging. Why, what is likely to happen next and what is the outlook?
The recent deterioration in US economic data, highlighted by the shockingly poor Q2 GDP numbers, has seen the markets pull the plug on their future growth and earnings estimates. Rising numbers of high-profile profit warnings from selected industrial companies have dominated a results season which has otherwise been broadly reassuring. Once more, oil at $120 has acted as a complete brake on economic activity.
Meanwhile, the latest ‘buy time’ rescue package for Greece was immediately tested by the markets pushing Spanish and Italian bond yields out, forcing further promises of fiscal retrenchment by them in exchange for the ECB stepping in to buy their bonds, forcing yields down. Finally, the S&P downgrade of the US credit status has caused markets to doubt the sustainability of the fiscal stimulus measures which have been so key to engineering the modest recovery seen over the last three years.
Common to the Eurozone sovereign debt crisis and the US credit downgrade is not only the debt itself, but a fall in market confidence in policymakers’ ability to tackle the debt and growth issues effectively. This is why the markets are rioting, effectively sending their signals of discontent much as those on the streets do.
Once the markets fall as heavily as they are doing, forced selling and a buyers’ strike ensure far heavier falls than would be justified by valuations, even on some pretty gloomy expectations about future growth rates or profit levels. It is at this stage that Governments and central banks have to intervene to stop the downward spiral and cause a more level-headed assessment of the outlook. We would fully anticipate such action pretty swiftly.
The concern is that the authorities have spent all their ammunition: the US downgrade flags more fiscal stimulus is unsustainable or counterproductive, whilst a credit downgrade to France would leave Germany alone to shoulder the burden of financing the ECB’s attempts to hold the Eurozone together. But it isn’t in the interest of those countries with sounder balance sheets – China, most notably – to stand idly by and watch the Western developed world slide into debt deflation and depression.
If there is to be further fiscal stimulus in the US, it should probably now be targeted not at lowering bond yields but supporting the housing market or employment growth more directly. In Europe, we need swifter progress towards fiscal union – some form of Eurozone bond issuance, perhaps, as an acknowledgement by Germany that it needs to put its credit rating behind its
fellow Eurozone members in perpetuity. Even then, there will have to be a revisiting of last month’s Greek rescue package involving greater recognition of bond losses and probable losses on Portugese and Irish debt too.
Meanwhile, equity valuations are cheap, with many securely-financed companies offering reasonable growth, rising dividends or good long-term prospects at prices which look very attractive. Whilst there will be downgrades to earnings forecasts for numerous companies over the coming weeks, the precipitous falls in share prices have priced in much of the bad news. The impact of falling markets on business and consumer confidence is not to be ignored, but equally the oil price now falling significantly is a real boost to activity.
At current levels there is no merit in being a panicked seller on any medium-term view. Many of the funds holdings have recently reported good results and represent very good value – which will be realised over time and in steadier conditions.
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