2Q18 CIO Insights: Quality Play
The February equity “flash crash”, coupled with a sharp spike in volatility, has without a doubt rekindled memories of the subprime crisis. Such concerns are warranted as global risk assets have rallied across the board since 2008 given the timely mix of monetary accommodation and rebounding macroeconomic backdrop. Today, valuations are no longer cheap and assets are deemed “priced-for-perfection”. Therefore, it would not take many negative catalysts for portfolio allocators to de-risk and undertake the flight to safety. However, before jumping the gun, a couple of pertinent questions one should answer are: Is the February fiasco a harbinger of things to come? Or it is just another mid-cycle correction?
We assign greater probability to the second scenario.
Historically, bear markets do not happen without a recession. Previous episodes of massive correction on the S&P 500 Index occurred when there were probabilities of recessions in the US. But this is currently not the case as the Federal Reserve Bank of New York is assigning only a low probability of a recession for the US (Figure 2). More importantly, corporate earnings stay robust and the sustainability of earnings momentum at the current level means that valuations have become cheaper after the recent pullback. Hence mid-cycle corrections typically provide attractive entry points for longer-term investors.
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