Matching market “will” with reality

-

Investors are currently pondering three questions: Is the current market assessment correct? Can the market create its own reality? Or are there buying opportunities?

Has it come, the big reversal? Let me counter with another question: Would you be taken by surprise if several sunny days were followed by a violent storm? On the one hand, you might well be, since it is amazing how often the weather stays the same as on the previous day. On the other hand, every meteorologist knows that a longer stable phase is often suddenly reversed, without any obvious “good” reason.

Markets sometimes behave in a similar way. The economic cycle has long since reached its autumn: risks have been rising. Towards the end of last year, we forecast a volatile year for equities in 2016 with only modest returns – but we certainly did not expect the extreme market turbulence we have experienced so far. The coincidence of an untested Chinese exchangerate regime, weak oil prices and worsening geopolitical tensions – adding to existing concerns, along with market illiquidity – served to trigger a market downturn. Events had forced everyone to review their assumptions, differently weighting positive and negative scenarios.

We ourselves have had to revise some of our economic and market forecasts since the start of 2016. Market turbulence is on its own enough to negatively impact the real economy via poorer sentiment indicators and financing conditions. Growth concerns are focused on two regions: China, which might be vexed by even bigger debt and growth problems than assumed, and the United States, where manufacturing has long since lost steam, with a looming decline of energy-related capital expenditure. U.S. consumption was meant to benefit from lower oil prices but there are growing doubts as to when this will happen, with the weakening of U.S. leading indicators now spreading to the services sector. At the same time, central banks seem to have lost their magic – or even their scope for action. So could U.S. companies start massive layoffs due to rising wage costs and stagnating earnings expectations?

Many investors are currently assessing the implications of such extreme negative scenarios. But there could be light amongst the darkness: markets may be exaggerating to the downside, meaning that market storms might soon be followed by sunnier days. Although we would remain wary about emerging markets, a selective approach may offer good opportunities within the equity and corporatebond markets in the Eurozone, Japan and the United States.


Stefan Kreuzkamp – Chief Investment Officer – Deutsche Asset & Wealth Management