Market turmoil - fortune favours the bold

Paul Niven, Head of Asset Allocation at F&C Investments, comments on the recent turmoil in global markets: "A 15% downward move in global equity markets since the beginning of the year has led many to conclude that the recent bull market is well and truly over, with the sharp sell-off in the past couple of days providing confirmation signal to a growing community of bears. The recent weakness has undoubtedly been both extreme and abnormal. However, it can be partly explained by the change in the fundamental backdrop for financial markets. The confluence of a deteriorating growth outlook in the US, in particular the perception that the Federal Reserve is 'behind the curve' in its response, and renewed strains in the credit derivatives markets have all triggered the unwinding of the risk trade.

The past month in particular has been characterised by a material deterioration in US leading economic indicators, with key economic releases such as the US Institute for Supply Management and the unemployment rate indicating that the probability of recession being discounted by markets had been underestimated. These were the first major signs that the economic slowdown is not confined to the consumer and the US housing market. Looming concerns over the risk to overly optimistic earnings growth estimates have compounded worries, whilst further weakness in credit derivative markets has continued to build fears over the stability of the financial system. Unfortunately, despite firm rhetoric over the willingness and ability of Fed Chairman Ben Bernanke to manage the cycle through interest rate policy, as well as the announcement of a larger than expected fiscal stimulus package, the perception remains that central bank intervention has not been sufficient. Signs of a clearing in the inter bank markets have not been sufficient and the market is now demanding aggressive interest rate cuts.

The combination of all of these headwinds for equity markets and risk assets in general justify a degree of negative price action. However, we expect the downside from here to be relatively limited. Signs of both panic and capitulation are emerging, with most major markets now more than 20% down from recent peaks. Supportive central bank action is likely in the near future.

Whilst implementing strategies based upon very short term moves in markets is both dangerous and often unrewarded, our risk appetite indicators are now within the 'panic' territory. In addition to this, the fact that markets are now moving significantly based on fairly limited news flow indicates that the bulls have capitulated, and markets are rapidly moving towards pricing in the more pessimistic potential outcomes.

Combining these risk appetite and technical signals with our view that any recession would be short lived, responded to by significant monetary stimulus, and confined to the US (whilst global growth remains intact) this leads us towards expecting a recovery in stock markets and risk assets in general over the coming months. Over longer term horizons, valuations within equities and particularly against other asset classes are becoming increasingly compelling. This is reflected in our quantitative process where our models now estimate a high probability of equities out performing bonds. Risks to economic growth, the stability of the financial system, and corporate earnings have clearly escalated. However, price action in equity markets has significantly moved towards reflecting this new environment, and we expect recent moves to provide a buying opportunity for bold investors who have the ability to tolerate short term volatility"