Amid the noise, the global recovery should remain the overriding investment theme of 2010
Fears, not fundamentals, are ruling the market
Amid the noise, the global recovery should remain the overriding investment theme of 2010
BY COSTA VAYENAS
The strong correction in bonds and equities in the last two weeks has put a dampener on the spectacular rally the market had experienced since March last year. This raises the question of whether the sell-off is simply a breather from the prolonged liquidity-driven momentum, or the start of something deeper given the rise of new market concerns.
We do not deny that 2010 will be bumpy for investors, but all indicators point to the correction being driven by fears, not fundamentals. There is no evidence of major headwinds impeding the ongoing recovery as business-cycle figures point up, central banks are still providing ample liquidity, credit markets are continuing to thaw, and corporate earnings are still surprising positively.
In our view, the three major fears casting gloom on the market – tighter financial regulation, central banks' "exit" strategies and tightening, and doubts about the fiscal sustainability of some sovereigns – are overblown. We do not view the recent sell-off as the return of the bear market that triggered the rout in 2008 and early 2009.
While we can expect some new banking regulations in the United States, the proposals under the so-called "Volcker Rule" are politically unrealistic and unlikely to pass in their present form. While China's monetary tightening came sooner than expected, it was the right move to stabilize its long-term economic growth. Similar stimulus-exit measures by other central banks should be viewed not as outright tightening but as signs of normalcy in the economy.
To be sure, the most recent source of investor anxiety – the dismal fiscal situation in Greece and other European countries – is unsettling. But it also has to be taken in context. The small size of Greece does not justify the market's overreaction, especially considering that Japan, the UK and the US are also confronted with massive debts and questions on their fiscal sustainability.
Amid the noise, investors need to distinguish between fundamentals and special factors as drivers of their decisions. With fundamentals still in line with market expectations, the global recovery led by the emerging markets should remain the overriding investment theme, and special factors such as what have triggered the recent correction can be viewed as a buying window for the risk-tolerant investor.
When the dust settles, the investment horizon should remain the same: floating-rate notes should be preferable to long-term government bonds, investment-grade and high-yield corporate bonds should remain attractive, the energy sector should still outperform, and European and emerging market equities should deliver solid returns. Along the way, investors can take advantage of the dollar's strength versus the euro, but only briefly – the dollar should remain weak in the long run.
Costa Vayenas is Head of Emerging Markets at UBS Wealth Management Research.
