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Market Volatility - Where are the opportunities?

In recent days we have seen considerable volatility across global stock markets. China has been at the epicentre of these gyrations, with the country’s domestic stock markets having posted significant declines since peaking in July and a slew of recent disappointing economic data. The most recent trigger for concern has been China’s move to devalue its currency, the yuan, last week – a measure we had predicted. This has spooked global markets, as it suggests the Chinese economy is in a worse state than many assumed.

Jason Hollands
25 August 2015

China has been a key driver of demand for raw materials, so a slowdown in China means continued weakness in commodity prices. This and the prospect of cheaper Chinese exports have raised renewed concerns about falling prices, ie deflation. That’s a double-edged sword, as falling prices can deter consumers from spending today, but on the flipside it also means interest rates are likely to stay low for longer than expected and weak energy prices puts more cash in the pockets of consumers.

Don’t get blown off course

In a situation like this it is understandably unnerving to read headlines about sizeable market movements and screaming about the value ‘wiped off’ shares. But as seasoned investors will know, periodic and often swift market ‘corrections’ are a feature of equity investing and often prove short-lived.

The summer months seem particularly vulnerable to these adjustments, as shares are thinly traded and prices can move on relatively modest volumes. Indeed to put this in context there were sharp summer sell-offs in 2011, 2008, 2002, 2001 and 1998. While the past is not a guide to the future, in each case investors who held their nerve rather than sold their investments in a panic were rewarded by the passage of time. We believe that long-term investors should not get blown off course by short-term market movements.

Of course no one knows when the current bout of volatility will end. Self-evidently though, when share prices have been indiscriminately marked down on a general turn in sentiment and relatively thin trading volumes, with no fundamental change on the outlook for a business, this clearly opens up opportunities for long-term investors. Markets have a habit of overshooting on the way up and the way down. We suggest that anyone inclined to invest new money into the markets, takes an incremental approach of feeding in their cash in phases rather than throwing all caution aside.

Risks and opportunities

We believe that given the deteriorating outlook for the Chinese economy it makes sense to remain cautious towards emerging markets despite valuations that may seem enticing, because company earnings could come under pressure. We are also very cautious on the outlook for commodities, and consequently remind investors that funds heavily exposed to FTSE 100, including index trackers, might hold sizeable exposure to oil, gas and mining companies as these are major constituents of that index.

The markets we relatively favour are the Eurozone and Japan, where the European Central Bank and Bank of Japan continued to engage in Quantitative Easing stimulus programmes – such actions are supportive for equity markets.

Examples of European funds we rate highly are Baring Europe Select, which focuses on smaller companies, and Threadneedle Europe Select, which is a core fund invested primarily in large businesses with strong brand.

Our top-rated Japanese equity funds include Man GLG Japan Core Alpha, which invests in large companies that the manager believes are undervalued and CF Morant Wright Japan which has a greater emphasis on medium sized businesses.

In the UK market, where large international FTSE 100 companies are estimated to have greater earnings exposure to emerging market economies than the UK domestic economy, we prefer funds with a bias towards more domestically orientated businesses, many of which are mid-cap companies. Funds exposed to this part of the market include AXA Framlington UK Mid Cap and the Standard Life UK Equity Income Unconstrained fund.

For those wanting to take a more defensive approach, it might be worth considering targeted absolute return funds. These are funds that aim to reduce exposure to overall market volatility and deliver positives returns across all market environments (but are not guaranteed). The two funds in this space which hold the highest ratings from our research team are Invesco Perpetual Global Targeted Returns and Standard Life Global Absolute Return Strategies.

The value of investments, and the income derived from them, can go down as well as up and you can get back less than you originally invested. This is not a personal recommendation or advice to invest. Past performance is not a guide to future performance.

Funds may carry different levels of risk depending on the industry sector(s) in which they invest. You should ensure that you understand the nature of any fund before you invest in it. Smaller companies shares can be more volatile and less liquid than larger company shares, so smaller companies funds can carry more risk.

Targeted Absolute Return funds do not guarantee a positive return and you could get back less than you invested, as with any other investment. Additionally, the underlying assets of these funds generally use complex hedging techniques through the use of derivative products, which can carry additional risks which may not be immediately apparent.

Different funds carry varying levels of risk depending on the geographical region and industry sector in which they invest.