October is historically the most volatile month for investment markets but the latest sell-off looks more than the usual Autumn wobble. A perfect autumn storm continues to batter markets. Worries over the state of the European economy, a strong dollar, a sluggish China, geopolitical tensions, US economy appearing weaker and falling inflation are driving markets down, as shown in the chart at the foot of the page.
But markets were long overdue a healthy correction and a reality check and by historical standards the current sell-off is not exceptional. What makes this correction interesting is that compared to other recent corrections cyclical stocks (those most sensitive to the economic cycle) are getting hammered while defensives have fared better.
Cracks are appearing in the US economic recovery, and therefore global growth. The underperformance of small caps this year were a warning shot – they provide early indicators of economic weakness. But also fears of deflation have spooked markets. So investors have quit equities (in particular cyclicals and momentum plays like tech) and are buying safe havens such as bonds.
Is it a buying opportunity?
The market correction means that equity market value has improved. The Ftse 100 for example is now trading below its long term P/E of around 14, making it more attractive as result of latest correction.
If you believe Europe won’t fall apart and global economic growth fears are overdone then a contrarian investor would be buying cyclical company shares and the funds that invest in them.
Will the correction carry on?
There’s certainly likely to more pain in the short term before the market finds a level of support. Will central banks step in to arrest a more significant sell-off.? Don’t rule it out as one thing that central banks fear is deflation and they have the power to inflate asset prices (and inevitably stocks) to avoid it.
Which funds should you buy?
If you are prepared to ride out the current volatility in equities then look to funds holding defensive stocks. If you are investing in the UK then a fund such as Invesco Perpetual Income, but it is not immune to market falls
If you are looking for funds to do well in this environment, and assuming it continues, look to bonds funds, as they are benefiting from falling yields as investors look for safety. Avoid high yield bonds and look for a soberly run UK bond fund such as Kames Investment Grade Bond which is up almost 3% in 3 months.
Alternatively get bond exposure globally. Threadneedle Dollar Bond’s performance has also benefited from a strengthening dollar, returning 8% in the last 3 months.
