Keep calm and be patient!
The recent market plunges caused some fears and panic among investors with more signs pointing to a market correction as it unfolds. Amidst the uncertainties also come with opportunities that investors can leverage at the same time.
We have experts at Eastspring Investments and UOB Asset Management to answer some of the most pressing questions and what it means to us.
With equity valuations so high, will the rally continue or will there be a correction?
Eastspring: We've started to see volatility spike and markets correct over the last couple of days, but fundamentally the "goldilocks scenarios" of positive GDP growth, high levels of liquidity, benign inflation and strong corporate earnings – which supported both equities and bonds in 2017 - haven't change as we march into 2018. Markets have rallied strongly over the past year with little consolidation; a reversal is to be expected, but will this then trigger end of the rallies? We don’t think so.
UOBAM: We don’t rule out corrections from time to time, even in a structural bull market. The 2003-2007 rally saw 7 instances where the S&P corrected more than 5%. However, if the cycle is not over, then the market will generally recover from the correction and continue to make new highs.
What are the possible opportunities in the market amidst the uncertainty?
Eastspring: Asia especially stands to gain from a synchronised global recovery, with China continuing to improve the quality of its economic growth and development. This is also positive for Emerging Markets in general, as they could benefit beyond current expectations if inflation remains benign.
A second development to watch for is the “form” an equity market rally could take. 2017 was a strong year for equity markets but interestingly the gap between factor performance in equities has been large – very large, in fact. Growth and Momentum led in 2017 while High Dividend and Value lagged substantially on a global basis. Low volatility stocks also lagged, but these stocks have recently seen a sharp uptick in the profit forecasts, which could lead to renewed investor interest.
If investors, however, prefer to stick with the developed markets, the pendulum is in Japan’s favour. Japan’s restructuring efforts have accelerated and are translating into higher operational efficiency, improved profitability and better cash flows (that are giving corporations more flexibility in repaying debt, boosting dividends and instigating share buy-back schemes).
We are equally mindful of the three bears too: higher-than-expected inflation, protectionism and politics. In this context, we think it is worth protecting portfolios from potential “tail risk” events. For this, we suggest including some exposure to low volatility strategies to the portfolios as well as to diversify across asset classes to include infrastructure and private equity in multi-asset strategies.
Where should investors allocate their equity exposure?
UOBAM: We believe the strong growth and other positive catalysts, such as tax cuts, in the US have been well telegraphed and discounted by the market. On the other hand, we think the surprise could be from Europe where expectations are still low despite strong leading indicators. As such, we would prefer Europe over the US in terms of our equity exposures. We also like Asia as a beta play on the global growth story.
What will bring inflation back?
Eastspring: Oil prices look poised to remain within a trading band, and this is unlikely to fuel inflation.
Core inflation in the US, Eurozone and Japan seems set to either remain subdued or fall short of target.
Structural factors also make it difficult for inflation to move significantly higher. The full implications of an ageing demographic, for example, are only slowly dawning on policymakers it seems. We are now encountering an ageing workforce, with many of them who are over 55 years old still active in the workforce. Older workers may need to be “reskilled” for the new economy, higher-paying jobs. Many may “need the job” and will accept low or no pay increments. In addition, low productivity may constrain the ability of employers to pay higher salaries.
As a result, there are strong grounds for arguing that the upward pressure on wages, for which various central banks have not only been looking but also basing policy, will be muted.
Nevertheless, the cost of getting this one wrong is high; we need to monitor this situation closely.
UOBAM: Generally inflation would require a rise in wages for it to be sustainable. The rise in oil price last year may cause some headline inflation (especially in developing countries where energy makes up a bigger part of the CPI basket) but core inflation, which excludes food and energy, are likely to be minimally impacted. In the past cycles, we need to see wage growth of 4%-5% before inflation starts to rise above the 3% range, the latest release in the US shows average wage growth of 2.9% despite unemployment rate at 4.1% (which is usually deemed full employment). There are some arguments of structural disinflationary trends, including change in demographics and consumption patterns, automation, etc. We will have to continue to monitor the inflationary trend to see how this ultimately plays out.
What will be most affected by a rise in inflation?
Eastspring: If inflation does rise, bonds will sell off. Equities could rally however, if that inflation is due to rising demand; rising demand would boost sales and eventually profits, and interest rates would have to rise a long way to cut this off. If, however, inflation rises is due to rising costs, then profits could be affected and equities come under pressure. As inflation looks to be relatively benign, despite jitters over rising US wages, we don’t see rising inflation as a major disruptor.
Will there be a recession soon?
UOBAM: None of our indicators show that there would be a recession in the next 12 months. Our current view is that interest rate will peak in end 2019, which would mark the top of the cycle.
Patience is key
It is important to be patient at this point and you may wish to consider using dollar-cost averaging to ride out the market volatility.
If you need any help, just speak to our friendly customer service representatives at 6220 7890 (Mondays to Fridays, 9 am to 5:30 pm excluding public holidays) or email us at cs@dollardex.com.
Want to know more about the impact of inflation during the recent market tantrum? Take a read here with expert views from Eastspring Investment.
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