Over a few weeks in May the MSCI World share index lost 13 per cent of its value. A sovereign debt crisis in Europe, new concerns about the prospects for growth in China, regulatory government initiatives aimed at curbing financial institutions, and even technical glitches all seemed to conspire to bring markets down in a hurry. Investors were surely baffled by the downward impetus and many may have wondered out loud: " I thought we were coming out of the terrible recession of yesteryear."
It is at times like these that old themes return to the fore: 1) Is this a correction or the beginning of a new bear market? 2) Do the fundamentals justify the extent of the decline? 3) Were investors so overly exposed to volatile equities to suggest there is a bubble? 4) What to do when markets come down so quickly?
Since March 2009, when equities began a steep rally, we have seen little sight of a correction and volatility stayed comfortably low. This, however, is not the normal state of equity markets and should not be expected to last forever. Conversely, the start of a bear market will typically reflect conditions significantly worse than those we are currently facing.
The European debt crisis should not be cavalierly ignored, as it will have consequences for European economic growth (though a cheaper Euro will also make European companies more competitive).
Clearly, slowing growth in China will have worldwide implications (but how much deceleration are we talking about anyway?). Notwithstanding, we should not ignore the fact that other economies seem to be gradually improving and demonstrating the return to normal economic activity levels.
So, to me, this is not the start of a bear market and the fundamental story remains a positive one.
It is possible that investors became a bit overconfident and were willing to expose themselves to equities beyond their acceptable levels of tolerance. The correction will redress that.
Sharp market declines will make any investor nervous. Managing investments in a countertrend fashion is in that sense a good, solid, approach. To wit: if markets have been on a steady run upwards, maybe it is wiser to reign in a bit and reduce exposure. Wait for the markets to correct so as to invest in cheaper opportunities later. I am well aware that market timing is extremely difficult, but actively managing a portfolio is more appropriate than simply holding investments in a passive mode.
