The United States equity market experienced a sudden bout of volatility last week Monday. The Dow Jones Industrial Average logged its largest point decline, closing down just over 1 175 points, although it had briefly dropped nearly 1 600 points during the day. It was the index’s largest one-day percentage decline since August 2011.
The ripples were felt around the world as Asian and European equity markets followed suit on Tuesday.
The suddenness of the decline has left some market observers searching for an explanation, with one being a recognition that the era of cheap money globally appears to be ending.
However, equity investors have had good returns for many years, so we at Franklin Templeton view a market correction as healthy.
When you consider that the markets have had a relatively strong, unprecedented rise over the past few years, market corrections can serve as an opportunity to improve valuations, so that it’s not quite as expensive to buy shares. This helps to make new portfolio allocations more efficient.
Investors should not confuse the market with the economy. We have seen real, solid economic growth globally. Companies that have low levels of debt, good earnings visibility, pricing power and positive cash flow should be able to do well even in an environment of tighter monetary policy and rising interest rates.
It’s important to stress that, although markets can be volatile in the near term, over the long term they reflect the underlying fundamentals of companies and countries. In our view, long-term structural growth drivers are still in place, and a slight rise in interest rates or inflation should not have a significant detrimental impact. Consumer spending, infrastructure, and technological innovation and adaptation are the long-term structural drivers of global growth, along with health-care innovation.
We recognise that challenges remain across the globe. Structural reform, while often unpopular, is needed in some countries. Elections can bring uncertainty and change, and there is always the possibility of policy errors or unexpected geopolitical shocks.
Staying the course
In times of market turmoil, it’s tempting to focus on the short term. However, it’s important to consider your long-term investment horizon and why you are investing, whether it’s for retirement, your children’s education or some other goal.
Market returns may vary over time, but, as long as the global economy remains healthy and companies continue to innovate and grow, we think there is still a case for staying invested in equities for the potential growth we see ahead.
Most investors have significant investments in their home countries, which in the realm of behavioural finance is called home-country bias.
For all investors, we think there’s a case to be made for diversifying across asset classes and markets to help protect against the negative impact of a single event.
Additionally, in times of volatility, we think active management can prove its worth. We recommend that investors consult with a financial adviser to determine the most appropriate portfolio allocations for their situation.
The recent market noise has not changed our view of the world. Although additional volatility may follow, we remain optimistic about the coming year.
Stephen Dover is the executive vice-president and head of equities at Franklin Templeton.