At the end of last February, a sharp price correction sent a short-lived tremor through the stock markets. At the time, the cause of the feverish, if fleeting, reaction of certain investors was the fall in US house prices and the growing difficulty of subprime debtors to make their payments. At the same time, the Chinese stock market abruptly plummeted, sparking fears that this was the end of the stock market cycle for China. While we did not take the gyrations of the Chinese market seriously, the news from the American real estate market coupled with obvious signs of slowing US growth did send a warning signal that the financial markets were potentially at risk. The solid growth in the rest of the world and especially developing nations enabled most of these risks to be offset, proving that the world’s economies continue to decouple from that of the United States. The February scare did not result in the risks in all markets being sustainably reduced, but rather laid the groundwork for them to resurface...

 

In July, just a few days after the Dow Jones reached its historical high, the market corrected again - this time more severely. This correction carried the seeds of more deep-rooted problems for financial markets, as entire sections of the credit markets virtually ground to a halt. Thanks to the rapid reaction of central banks and quick realization on the part of governments of the dangers of allowing such a situation to deteriorate, market conditions are gradually smoothening. Still, it seems that the cost of credit is set to continue climbing and, as financial transactions become more expensive and less accessible, most players are reassessing the risks. The central banks will likely keep the liquidity taps turned on, but we expect the capital to circulate more slowly as the banks tighten their credit policy.

 

Equities paid dearly for the closing of the credit markets this summer, even if some quickly recovered. It would appear that most of the meltdown can be blamed on the fact that only the huge liquid market remained during this period, and was therefore fertile ground for all sorts of hedging operations and forced sales. Once this particular period had ended, the gradual thawing of the credit and interbank loan markets has given equities back their momentum, so that they better reflect the trend of company profits. We are convinced that equities are generally recovering their status as the preferred asset, while the markets in which credit/leverage (bonds, property) plays such an important role have reached high valuation levels.

 

As discussed above, more evenly balanced global growth, the accumulation of exchange reserves in developing countries, the creation of Sovereign Wealth Funds, and a satisfactory channel for earnings will all support equities in the mid term.

 

In this context, we like large caps with growth opportunities in the biggest markets and decidedly heavy exposure to those emerging markets with the best investment opportunities (Hong Kong, Korea and Brazil in particular). This preference is a special take on the "core-satellite" approach, which clearly shows these new financial market drivers in an increasingly significant role.

 

Serge Ledermann, Responsible for Strategy and Investments