An extract of the September 2008 edition of Investment Strategy:
Many questions, particularly about emerging economies
The behaviour of equity markets over the summer reflects the current uncertainty about the outlook for the global economy, the soundness of the financial system and its potential impact on the real economy. Investor confidence in the economic situation and in the outlook for inflation has been subject to particularly wide swings, in accordance with changes in economic indicators and oil prices. After falling 2.7% in dollar terms in July, the MSCI AC World index fell an additional 2.4% in August.
Our baseline scenario is one of economic growth that continues to be “soft” over a relatively long period. We think there is little chance of a global economic recession now that the United States is showing some signs of recovery, or at least stabilisation. Although Europe’s economy has been weakening rapidly and will continue to slow, we believe the current pessimism is probably excessive, despite the somewhat sluggish response of the region’s monetary and fiscal policies. Investors are most concerned about the emerging economies, where they see political risks (e.g. Russia and Thailand) and higher inflation, slower growth, restrictive monetary policies and some currency weakness (in Asia and eastern Europe). These concerns explain the flow of capital from these regions and the 4.2% and 8.2% declines in the MSCI Emerging index in July and August respectively, in dollar terms.
A “trading-range” market for equities
Although the current environment is likely to weigh on sales and earnings for quite some time, there are some supporting factors for equity markets. Low valuations may of course continue to limit any further drops in share prices. But as we have pointed out previously, valuations alone are rarely sufficient to trigger a bull market.
Among the various economic factors, the drop in oil prices from almost $150 a barrel in mid-July to less than $110 in early September could breathe new life into the market by bringing down inflation. Much investor skittishness over the past few months can indeed be attributed to rising prices, which have been squeezing corporate profits and eroding consumer purchasing power. The energetic response of US government officials is also likely to be a supporting factor. The Treasury’s announcement on 7 September that the government would take Fannie Mae and Freddie Mac under its wing was well received by investors, in large part because this once again sends a clear message that US officials are ready to do everything in their power to avoid a systemic crisis.
Given these potential supporting factors it would certainly not be a good idea to drastically reduce exposure to equities. Over the next few months we expect equity markets to respond quite sharply to economic indicators, business news and technical factors.
Although emerging markets still offer excellent potential over the medium to long terms, we expect the lack of visibility to keep them quite them turbulent over the near future.
“Investment Strategy”sets forth the different asset allocation choices which are implemented in BNP Paribas Asset Management’s portfolios. The investment strategy derives from a running analysis of numerous factors (i.e. the general economic situation, earnings growth rates and financial ratios, assessment of market valuations, technical analysis).