Stephanie Flanders: Brace yourself for slower global growth

Stephanie Flanders 700 x 450

Investors returning from the beach this September had a bumpy re-entry, with markets rocked by growth fears in China and uncertainty around the timing of rate rises in the US. The market ructions were a useful reminder that we should expect more volatility at this stage in the investment cycle – and lower returns. But for the well diversified investor this is no reason to panic or head for the hills.

The fact there was a correction was not surprising after such a long period of relative calm for equity markets. But the scale of last month’s spike in volatility did take many investors by surprise.

The Vix — otherwise known as the “Fear Index” — breached the 50 mark for the first time since 2009 and the S&P fell more than 11 per cent from its peak over six consecutive days. Strikingly, the S&P 500’s fall represented a five times standard deviation against its 50-day moving average. That has only happened twice since 1900: on Black Monday in 1987 and when Germany invaded France in 1944.

Much of this volatility was related to market liquidity issues – including the fact that many traders were away. But it did not come out of nowhere. In fact emerging market indices had been under pressure for some time, with the MSCI Emerging Markets Index having moved earlier – and more extensively – than other markets in reaction to the situation in China.

Having risen strongly over the course of this year, the Chinese stockmarket experienced a very messy decline at the start of the summer. Most global investors were reasonably relaxed about this, having predicted a pullback in this overexuberant market. That China would eventually need to adjust its currency was also widely anticipated. What spooked investors was not so much the fact of these developments but the muddled way that Chinese policymakers handled them.

A downward move in the Chinese renmimbi of around 3 per cent is not the end of world, and still leaves their currency much stronger in real terms than a few years ago. But investors worried that this could be the start of a long series of moves, and that China’s policymakers could be losing control.

This concern about China came against a backdrop of weakening momentum in emerging markets generally, which are particularly hard hit by recent declines in commodity prices, another side of weakening demand in China. We have also seen a stagnation of global trade, which has been growing slower than global GDP for the first time in decades.

All of these factors put pressure on emerging market economies and also mean global growth is likely to be slower than we were used to before the financial crisis. That said, most of the developed world is still seeing reasonably healthy growth – there are none of the tell-tale signs of an impending recession in Europe or the US. Without that kind of shift in the business cycle it is difficult to see why we should be heading for a true bear market in the near future.

Some will have viewed the August pullback in developed markets as a buying opportunity. If you were buying equities before the turbulence, you would have to say they are better value now than they were a few weeks ago. Valuations measured by forward price earnings ratios in Europe, the US and UK are not cheap, but with this volatility they have fallen back to their long-term average.

Unequivocally this has not been the time to sell. The roughly 11 per cent market decline that we saw at the lowest point in the recent turbulence is very much par for the course in equity markets: in fact, the median intra-year drawdown in the FTSE 100 for the past 29 years has been 11.3 per cent.

We have seen unusually low levels of volatility recently, in part due to the distorting effect of central bank policies around the world. But this is the stage in the cycle when investors should be expecting volatility to rise and returns to be more constrained by economic fundamentals.

After a five-year bull market, where bonds and equities were initially driven by reasonable valuations and accommodative central banks but are now no longer as cheap as they were, it is more critical than ever for investors to carefully pick their entry point and price. Investors should steel themselves for more constrained returns and greater volatility, by diversifying more and expecting less.

Stephanie Flanders is chief market strategist for UK & Europe at JP Morgan Asset Management