Flash – Equity markets

Early October, we witnessed a global drawdown in equity markets. The Eurostoxx 50 lost about 5,50% since the end of September (as of 15/10/2018), while the Stoxx Europe 600 lost about 6,15% over the same period. In the US, on October 11^th , the S&P 500 had its worst session since February, and we would have to go back as far as the Brexit to find an as powerful one-day correction for the Nasdaq. Nevertheless, this market reversal remains relatively limited on a historic basis, even if it is significant when compared to the peaks we have reached during the year. On the other side, securities that had previously underperformed proved rather resilient, especially “value stocks”.

 

Data as of 15/10/2018.

 

At present, this market behavior is globally in line with our anticipations, in other words, a very high concentration on certain securities that drove the index performances upwards, especially on growth stocks and the biggest market winners of the past few years – i.e. technological securities in the United States, and small and mid-caps in Europe.

Our funds have an important bias towards technological and growth stocks, and have as such surrendered a part of their outperformance, but still remain globally above their respective benchmarks.

 

The facts

There was no specific triggering factor to this market movement. In fact, the cause of the slump can be found in the cumulative effect of several catalysts that had already been present for several months – the trade conflict between the US and China, the fears of a slowdown in Chinese growth and a hostile attitude of the Italian government, in refusing to review its budget. The drawdown was further amplified by two factors – the drying up of liquidity (September and October being traditionally the months for profit-taking by investors) and the very high concentration of positions in a narrow range of sectors and securities. All these factors to be placed in a context where the market is split between European growth that is showing signs of slowdown and an American economy that seems to be running beyond its potential.

It is in fact the combination of these threats that explains this rise in risk-aversion, prompting investors to take their profits over the full range of risky assets, especially on the best-performing strategies of the last few months.

Finally, although the phenomenon of a sudden acceleration in downward movements may appear surprising, it has almost become “standard”: rapid increases in flows during times of stress have become the norm with the rise of algorithmic strategies.

However, in the short term, this normalization doesn’t take place exactly like we anticipated. Our positive view of the macroeconomic context led us to believe in a convergence in valuation levels, with current underperformers returning to better fortune and a progressive normalization of growth stocks. This is not what happened: in fact, over a few days, the valuation convergence occurred in down markets, with growth stocks being strongly punished due to their recent strong increase in valuation multiples (that were justified by the strong growth of their results and their positive industrial trends).

 

Outlook

We are not really surprised by the effect of convergence in the performance of stocks. The level of divergence observed since the beginning of the year between growth stocks and the rest of the market did not seem sustainable over the long term, and therefore needed to converge. This drawdown will enable the markets to start on sounder foundations in 2019, with a better alignment of valuations.

Today, in a context where no genuinely new elements have appeared, our central scenario remains unchanged and is centered around a progressive normalization of growth stocks, but without any reversal.

We will remain particularly vigilant on the upcoming earnings releases, which should reassure the markets and re-focus on the promising microeconomic trends rather than the macroeconomic vision that has prevailed for the last month.

 

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