3 reasons why poor market performance is a blessing in disguise
This article highlights why poor market performance can be a blessing in disguise for contrarian investors.
The market shakeout of the past few months has led to a significant downward adjustment in investor expectations. We have now seen a major reset in expectations, providing the springboard and the foundation for a renewed phase of market strength. Below, we highlight why poor market performance can be a blessing in disguise for contrarian investors.
Easing financial conditions will foster better growth prospects
The correction in risk assets over the past few months led to a meaningful fall in global real yields. In a world with little growth impulse and mediocre pricing power, there is a strong need for self-correction dynamics of this kind (whereby occasional bouts of growth fears have driven the fall in bond yields). Such a correction helps avoid a premature tightening of financial conditions capable of choking off the fragile growth backdrop.
This is an important point as we know that the global market downturn and the European recession in 2011 was pre-empted by a rising real yields which stifled the fragile post-Global Financial Crisis recovery in Europe.
The bottom line is that the significant drop in global real yields since August this year is likely to be a blessing in disguise; facilitating stronger growth prospects over the coming months. While yields are now once again on the rise, the upswing is associated with improving global growth prospects.
The US market has joined the global correction
The adverse impact of the rising US dollar on global financial conditions appeared to be ignored by the US Federal Reserve (Fed), who was seemingly intent to lift rates just on the basis of an improving US employment backdrop. In August, as the US market joined the global correction (a blessing in disguise), the US Federal Reserve’s conviction to raise rates in the face of slowing global growth faded.
A likely break in the vicious cycle of ongoing US rate hike expectations has led to plunging emerging market currencies and tightening of financial conditions in the emerging world.
A less volatile emerging market facilitates adding to growth exposure
The reduced risk of policy error by the Fed, emerging market currencies have delivered their best reversals (reminiscent of the 2011 and 1998 crisis/correction):
- The Chinese Yuan Renminbi has shot up to its strongest level since the mid-August devaluation; and
- Bullish risk reversals were seen across a myriad of other emerging market currencies (Indonesian Rupiah, Brazilian Real and Russian Ruble) which have been at the epicentre of the global correction in risk assets.
With the US Federal Reserve putting a material weight on emerging market developments, the one way traffic out of emerging market currencies into the US dollar is likely to come up against significant resistance.
Short-selling emerging market currencies in the face of an exhausted downtrend is going to be very expensive. This could be a good thing because stability in emerging market currencies has been a key condition for adding to growth exposure.
While it is premature to call a strong, directional and sustained rally in emerging market foreign exchange, the indiscriminate and unrelenting phase of emerging market currency selling is likely behind us.
Earlier in the year, investors’ perception of risk was low, the global growth forecast was a decent 3.5% for 2015 and volatility was relatively benign. Since investment risk was ‘perceived’ to be low, this left lots of room for downside surprise in a world mired in messy and uneven growth.
Now, after a few turbulent months in markets, rising volatility, and downward growth revisions, investors’ perception of risk has climbed significantly. The sharp adjustment in investor expectations and the widespread recognition of risks now leaves plenty of room for upside surprise. This does not necessary require the macroeconomic backdrop to miraculously turn from bad to good; it just needs to become less bad.
We have seen this unfold in markets since the start of October with a strong recovery in risk assets. All this shows that market turmoil can create significant opportunities for contrarian investors.
About the author
Nader Naeimi, Head of Dynamic Markets at AMP Capital. He is also the portfolio manager of the Dynamic Markets Fund