Equity market outlook – Déjà Vu

The global noise emanating from Greece and the United States is a bit unnerving, but it is comfortingly familiar at the same time. The similarity was of course in broad strokes; with the teetering Greece economy threatening to drag down the European Union (EU) growth prospects - seemingly like the US housing bubble knee-capping the US economy. Similar noises were made then and they are being echoed now.

In respect to this, the EU will be dragged down for the next few years whereby the contagion effect and austerity drives will make European assets less attractive and the EU banking system will be under pressure from their loose lending standards to emerging Europe.

Similarly, the SEC investigation into Goldman Sachs’ sales practices sounds like the one made by the Government on the banking system 2 years ago and comes very close to emulating the Lehman’s mini-bonds saga.

The reassuring part of the equation stems from the "been there, done that" approach and how policymakers and markets are viewing these situations. The difference between now and 2 years ago was that markets know the ending, having seen the script before. We could call it global financial crises redux, or v2 if you may.

The announcements over the weekend underlined the EU’s actions on similar lines. We expect comparable measures to be implemented as they have worked before, as there is no point reinventing the wheel. Hence we expect government bailouts to continue (of other governments, not banks) and low interest regime to continue in the EU and in the UK.

Looking at this situation, what does it mean for the rest of the world? The low interest rate regime in the EU and the Fed continue holding low rates means that assets may underweight EU countries due to perceived currency weakness, thus benefitting emerging markets and the US. In the near term, we see these markets and currencies rallying from the movement of capital to better performing economies. This will add pressure to central banks to reconsider hiking rates, which will further fuel painful currency appreciation.

In this environment we believe the US markets and USD may be strong for several reasons. Firstly, the safe haven status of the USD. Secondly, the US bond market is the most liquid asset class globally and is capable of absorbing the billions of assets from rebalancing global portfolios.

Hence, in this scenario, the US market may not underperform emerging markets. This is actually perversely positive for emerging markets, as these markets would have been unable to absorb all the flows from Europe. These flows could have caused emerging markets to spike, and then endure a significant correction.

As the Chinese authorities’ tightening stance adds up to medium term bullishness for equities, we are not changing our view on equity allocations. While we are cognisant of the possible volatility as these events play out, we believe these aftershocks do not have the potential to drastically change the course of the economic recovery. However, in light of the volatility we are lowering the beta of the portfolio to shield it from unnecessary volatility.