The International Market: Full of Corrections
by David Sheasby, Director, Global and International Products, Martin Currie Investment Management, Ltd.
Markets have fallen very sharply over the past 10 days in a wholesale rush out of risk assets. Since July 27, the MSCI EAFE index has fallen by 14.7% (in U.S. dollars), a substantial move in a very short period of time. The key pressure point is the European sovereign debt markets, where yields in those markets perceived to be the most vulnerable have continued to climb.
In the U.S., the political brinksmanship around the debt ceiling debate unnerved investors and likely contributed to the credit rating downgrade announced this weekend. While the increase in the debt ceiling came down to the wire, the accompanying soft economic data coupled with some cautious comments from company management during their results calls has also led to selling of cyclicals, financials and other companies with leveraged balance sheets.
Corporate results have been mixed, and companies that announced positive surprises have tended to be positively rewarded, especially if accompanied by an upbeat outlook statement. However, negative surprises have been hit hard by the market. The results season has gone well in Japan with the downward revisions after the earthquake now seen as overly pessimistic. In the rest of Asia the season has also been generally positive, but in Europe it has been much more mixed, partly due to the impact on currencies during the second quarter. Notably, industrials and materials names have been hit by higher costs and have exhibited some caution in their outlook statements. Financials have been very mixed.
2008’s economic vulnerability was offset by stimulus in China and packages in the U.S. and Europe. Is there any flexibility for a third round of quantitative easing or any other form of stimulus in the current environment with its focus on government balance sheet repair? The debate is complicated — at one end there is a need for growth to meet fiscal targets — and at the other, the need to manage government debt levels. The country with the greatest potential to stimulate demand is China, and the feeling is that we are at the point where that country’s tightening program, that has long captivated investor attention, is drawing to a close.
We have made some minor adjustments to our strategy in recent weeks - principally a reduction in exposure to some of the financials and more cyclical mid-caps. The portfolio is structured to allow stock selection to drive returns irrespective of market moves and its volatility remains close to market levels.
The view we continue to hold is that emerging markets offer the potential for growth while developed markets remain constrained by fiscal austerity-which will last for several years to come. In periods other than those of peak stress, companies exposed to secular trends in education, health and rising emerging market consumption should outperform, and we have exposure to these kinds of names across the portfolio. The recent results season confirmed the underlying strength in these businesses and we remain committed investors.
In summary, the issues impacting global markets are deep-seated and reflect challenges that first emerged during the 2008 global financial crisis. The widespread inability to adequately resolve these concerns — with the solution to growth concerns in the U.S. and Europe particularly evasive — has led to the current period of market volatility.
Market valuations are attractive and corporate balance sheets are, by and large, robust. We are very confident in our portfolio positioning into this decline. While we do not expect a sharp and sustained recovery in markets, we do anticipate a rally after the extent of the falls witnessed to date. This will likely be most sustainable in markets within, and companies exposed to, Asia and global emerging markets. Markets are likely to continue to be volatile until a growth agenda is understood and credible solutions to sovereign risk are articulated.
Mr. Sheasby joined Martin Currie in 2004 as a director in its global team. He is lead portfolio manager for the EAFE ADR strategy and supports the managers of the global ex-US portfolios. Martin Currie is a sub-advisor for Calvert International Equity Fund.
This commentary represents the opinions of its authors as of August 9, 2011 and may change based on market and other conditions. The author’s opinions are not intended to forecast future events, guarantee future results, or serve as investment advice.
Investment in mutual funds involves risk, including possible loss of principal invested. You could lose money on your investment in the Fund, or the Fund could underperform, for the following reasons: a) the stock market may fall in value (including stock markets outside the U.S.), causing prices of stocks held by the Fund to fall, b) the individual stocks in the Fund may not perform as expected, and c) the Fund’s portfolio management practices may not achieve the desired result. Foreign investments involve greater risks than U.S. investments, including political and economic risks and the risk of currency fluctuations. In addition, the risks of investing in emerging market securities are greater than those of investing in securities of developed foreign countries.