Was that a dead cat bounce or have we seen the end of the rout in global stocks - time to scale-up risk?
No man’s land is defined by the Cambridge English Dictionary as an area or strip of land that no one owns or controls. That is exactly where the global equity market finds itself. It is currently not controlled by the bulls (those who view the current market conditions as an opportunity to add to their equity holdings) or the bears (those who are negative on stocks and see further significant downside).
For some time now I’ve advocated a “Fade Risk” strategy which comprised the addition of gold to emerging market portfolios and the overweighting of consumer staples stocks in global equity portfolios.
The global stock market’s movements over the past few weeks have changed the picture dramatically.
My proprietary market risk indicator jumped from -4percent at the end of September to +10percent at the end of October. Over the past 19 years a break above 0percent (neutral) to +15percent indicated a minor correction in a bull market and therefore a buying opportunity - scaling-up risk.
Levels above 15percent indicated a major correction and even the beginning of a bear market.
At this stage it seems we have and still are experiencing a minor correction in a bull market and, yes, it may be time to scale up risk by reducing gold holdings in favour of emerging market equities and reducing exposure to consumer staples stocks in favour of growth stocks. But what do the underlying fundamentals say?
The stock markets are offering value again. By my calculations the rating of the US equity market as measured by the Shiller PE Ratio of the S&P 500 on Tuesday was 31.1points - a 9percent discount to what it should be, given the current consumer sentiment index in real terms.
That same day the rating of developed market equities as measured by the Shiller PE Ratio of the MSCI World$ Index was 22.5points - a discount of 8percent to what it should be given the latest G7 Business Confidence Index level.
A recession in the US is not in sight yet. The US yield curve as measured by the gap between the 10-year and two-year government bond yields has not yet signalled a peak in employment in the US.
The US still has ample spare capacity with capacity utilisation currently at 78percent compared to the highs (and pre-recession peaks) of 83percent in 2000 and 2006.
Trump has already gone softer on his stance on tariffs with America’s neighbours and some other countries. He conceded a lot on the sanctions on Iran - most importantly, major economies such as Japan, China, India and South Korea will be allowed to import Iranian oil.
The current scale of the stimulus measures and possible market intervention by China is such that it could add spark to the global economy - as it did in 2008/2009 when it pulled the global economy out of the slump caused by the global liquidity crisis.
Technically speaking, global equity markets are nearly as oversold as they were near the bottom of the markets in October 2015.
In my opinion there is a more than even chance that a post midterm election rally will happen and that the year will end on a higher note.
It is also possible that the highs in developed market equities may be tested again. It is also likely that the rout in commodity prices such as copper and commodity-related equity markets and emerging market assets and commodity-related currencies may come to an end.
Big ticket stocks such as Amazon and Apple, down 20percent and 13percent from their recent highs respectively, may regain their glitter.
I do see it as a high risk rally though as the so-called elephant in the room, Trump, is capable of disrupting markets and economies at any time through statements and efforts to increase protectionism.
The outlook for next year is also highly uncertain as the markets are likely to continue to lose momentum.
Ryk de Klerk is an independent analyst. Contact him at [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice.