Investors should beware the increasing possibility of a major equity market sell-off, according to IG market analyst David Madden.
In mid-morning trading the FTSE 100 continued to fall today, following a downward trend seen since the end of April which has caused the index to shed close to 7 per cent. Our data, which does not include today’s further losses, shows this in the graph below.
Performance of index since 27 April 2015
Source: FE Analytics
Since UK equities had their last significant period of downside in October last year, when they plunged on a host of fears ranging from the Ebola crisis to the geo-political tension in Ukraine and the Middle East, they have moved swiftly upwards and eventually broke through the psychologically important 7,000 barrier.
Seemingly the UK economy is in rude health with unemployment at its lowest for seven years and wage growth at its highest for four years. This is accompanied by low, but positive inflation.
However, the worry of the rising potential of a chaotic ‘Grexit’ as the beleaguered country and its creditors’ deadlock remain strong and stock markets are being shaken by the lack of progress in the negotiations, Madden says.
“As the clock keeps ticking traders will become more and more nervous. The stand-off between Greece and the European Central Bank [ECB] continues and there is still no sign of an agreement in sight. The word ‘default’ is being bandied around the trading floor even more so and there are only so many times dealers will stare at the sea of red screens before they jump ship,” he said.
“The left-wing Syriza is determined it will not be the first one to blink and the ECB continues to stand its ground, but playing chicken with people who have
nothing to lose is a dangerous game.”
“The pressure is intense, even by Greek debt crisis standards, and one by one dealers are ducking of out the market. Many traders are wishing they had sold in May and gone away, as it is shaping up to be a long and painful summer.”
Tony Lanning, manager of the JPM Fusion fund of funds range, is also taking a newly bearish strategy of late, believing that raising his cash position across the funds is the best course of action for 2015’s choppy markets.
“In the last two years, equity markets have performed strongly, with the MSCI World Index up over 40 per cent since spring of 2013. Risk assets have benefitted from a low inflation environment, accommodative central bank policy action and accelerating global economic growth. We’ve reflected this view across our range with an overweight to equities and credit and an underweight to core bonds,” he explained.
“At the beginning of March this year however, we chose to pare back the equity weightings in the funds for the first time, reallocating the proceeds to cash and liquid alternatives.”
“Equity allocations have been cut across the board rather than any specific region and cash in the portfolios is now at its highest level since launch. We’re positioned to be able to redeploy that cash at a more opportunistic time.”
Lanning says his cash weightings now varies between 7 per cent and 11 per cent weighting, depending on the fund.
It does not seem to have hurt performance, with the JPM Fusion Balanced fund ahead of the IA Mixed Investment 40%-85% Shares and ahead of the FTSE All Share since March which have gone down.
Performance of fund, sector and index since March 2015
Source: FE Analytics
Anthony Rayner, co-manager of Miton’s multi asset fund range, is also expecting markets to be further characterised by “elevated bouts of volatility” and less liquidity over the summer.
He says the world’s leading central banks are starting to see the effect of their strategies of ‘easy momentary policy’ – most notably quantitative easing – dwindle, making further upside less likely.
“Investors have become so used to central bank dominance and so rewarded by falling into line behind every new policy, that herding behaviour is being exaggerated. As markets have adapted, central bank policy seems to be contributing to increasingly unstable outcomes. For example, the backing up and the volatility of the German bund yield and the related strength of the euro, effects which are being felt across financial markets,” he said.
“Recent noises from the European Central Bank indicate they are comfortable with more volatility, and they may be, if it’s a path towards more ‘normal’ behaviour in financial markets, characterised by a return to more ‘two-way bets’ in markets.”
“However, central banks generally prefer more orderly movements in asset classes and the ECB might well have avoided expressing discomfort around renewed volatility in order to protect credibility.”
Rayner adds that diverse asset classes are showing signs of increased fragility, making the broader investment landscape less appealing.
“Certainly, the recent behaviour of the German bund is not consistent with any ‘safe-haven’ status, while the very volatile moves in Chinese equities does not suggest an orderly transmission of policy.”
“In short, it feels like the new monetary regime will be prevalent but, perhaps, less dominant and, in terms of investment opportunities, the risk/reward opportunities seem to be becoming less favourable.”
While a correction could be on the cards, Luca Paolini, chief strategist at Pictet Asset Management, says investors should not expect any sort of large crash reminiscent of the financial crisis.
“There this a very low risk of a large crash despite the greater volatility,” he said.
“You normally have a big correction when valuations are higher and when everyone is very optimistic and has leverage positions. Now there is not much optimism and everyone is actually quite cautious. So there is a lot of pent-up demand which should support the market although this doesn't prevent the risk of market correction but something like 2008/9 – I find it difficult to see."