Kames Capital reacts to ongoing volatility across markets

Scott Jamieson, Head of Multi-Asset Investing at Kames Capital comments on current equity market turbulence.
 
“UK equity markets peaked-out around the end of May. Since then (to last Friday, 21 August) they have fallen by 11%. The slump has been much worse in China. A major correction has occurred; it may be well advanced.
 
“The sell-off is being driven by a series of factors. Energy markets are being hit by excess supply – the US rig count has risen again (despite the contraction from last winter’s oil price weakness) and Iran is coming back on stream strongly – and has vowed to do whatever it costs to defend its market share. This has hit the natural oil producers, many of which are emerging markets. Many of these countries were already being impacted by the prospect of tighter US monetary conditions, consistent with the possible lift in US policy rates. US monetary policy seems to be driven less by current and prospective inflation – a raft of central banks are struggling to explain current inflation rates – and more by the need to move away from an emergency setting. Many emerging market nations have pegged themselves (or have a pseudo peg) to the US dollar, and the stronger dollar of recent years has impacted their competitiveness; nowhere has the cost of ‘coat-tailing’ the US been more challenging than in China. Combine all this with a multi-year equity rally, which has left standard valuation metrics looking challenging, and the ingredients are there for some significant soul-searching.
 
“And yet, second-quarter EPS growth in the eurozone and Japan was 20% and 33% respectively – admittedly it fell 3% in the US; trailing 12-month earnings per share rose 3.6% in the UK in the second quarter. Things are challenging for companies but not yet overwhelming
 
“The current turbulence may yet impact the US FOMC’s thinking – we should remember that its own staff think the world to be much less robust than committee members judge. There is certainly a need for emerging markets to decouple further from the US – inevitably a process fraught with challenges. However the world economy has generally been outperforming expectations and we are not yet contemplating a world without growth.
 
“No one knows what the fair value of equity markets is at any given point in time. As valid a measure as any is the discounted dividend approach (reversed out of the prevailing interest rate curve). On this basis, UK equity dividends hardly ever need to grow to look better value than bonds. The equivalent figure in the US is back to lows only seen in the financial crisis
 
“China will be key in determining any turning point. China has been the secular growth story upon which many investors depended – that argument now looks to have gone ex-growth. Many investors – including domestic Chinese players – will need to adjust accordingly. The challenge for them is that there aren’t many decent growth stories around; perhaps finally the adjustment process to a low return, low inflation world has begun. How will balance sheet managers react if the bond market proves to have been correct all along?”