Global equity sell-off- Where do we go from here?

Following the recent sharp sell-off in global equities, Paul Niven, Head of Asset Allocation at F&C Investments in London, comments:

"Turbulence in global markets has returned, prompted by a rout in Chinese stocks on fears of authorities intervening due to concern over the pace of gains in the local A-share market. In addition to this trigger point, there was a very weak data point on US durable goods orders for January, increasing concern over sub-prime lending, and ex Federal Reserve Chairman, Alan Greenspan, commented that the US could face recession later this year.

These factors have been responsible for a sharp pullback in global equity markets from recent six year (and in some cases record) highs, a spike in market volatility, a rally in government bonds, widening credit spreads, and a fall in the dollar.

For investors, the question is, where do we go from here?

In short, our view is that the equity sell off is unwarranted on fundamental grounds. On our measures, risk appetite was not particularly extended and, while some markets had reached a short term overbought level, we did not see grounds for a material setback.

Assessing the factors which have led to the pullback in markets leads us to the conclusion that recent price action is technically driven rather than fundamentally warranted. Following a prolonged rally in risk assets what we are seeing right now is a partial unwind of investors' positions, rather than a wholesale change in the drivers underpinning the economic backdrop.

On the Chinese market, linkages between the domestically owned A-share market and the Chinese economy are trivial and are even less important between Chinese equities and the global economy or earnings. In addition, the volatile series of durable goods order which was cited as a trigger yesterday does not change the picture that US economic data has been mixed, rather than weak. Furthermore, housing sales and consumer confidence came in better than expected in the US.

What we can see right now in markets is price contagion from Emerging into developed markets and ex-post rationalisation for the wave of risk aversion. History tends to suggest that such episodes, if not warranted on fundamental grounds, can last some weeks and that areas which have led the rally in risk assets will also lead the decline.

In our view, this episode probably has a little further to run but should not change investor positioning materially. Global growth and earnings are well underpinned, inflation will decline modestly, and valuations are relatively attractive in global equity markets. Near term risks centre on Emerging market equities but if price weakness in global markets continues apace, we will look to invest into equities to increase risk on portfolios from current, low, levels."