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Is this final market wave about to hit the rocks?

Global equity markets are experiencing their worst start to the year since 2008. While some are fearing this is the start of a bear market, others believe markets are oversold and equities now look at their most compelling in years. There are valid arguments on both sides, but some seem more right than others.

During the first 20 days of the year, the MSCI AC World Index was down 10.8% in euro terms. While no asset manager had forecasted this sort of market correction for the year to start with, there is widespread consensus that fear about what’s happening in China is the catalyst, and that the market has overcorrected.

Joachim Klement (pictured right), chief investment officer at investment consultancy Wellershoff & Partners in Switzerland, had predicted in September last year that a market correction was on the cards for 2016. However, he hadn’t expected it to occur so soon, and he believes the present correction is overdone.

“The current drop in global stock markets is driven by uncertainty around China. At the moment we see some exaggeration in the market so we have positioned ourselves for a rebound during the coming weeks and are now neutrally weighted in equities,” says Klement.

The final overweight

Jaap Bouma, a senior portfolio manager at the Dutch wealth manager Optimix, agrees with Klement. “We kept our equity allocation neutral until Wednesday last week, and then increased it to 52% from 47%, because I think the market was heavily oversold at that point. There simply had to be a tactical bounce,” he said. And this rebound indeed came, as markets went up on Thursday and Friday on the back of dovish comments by a central banker – Mario Draghi – before the rally ran out of steam on Monday.       

Both Bouma and Klement believe the bounce back they are expecting will be short-lived. “If markets go up another 5%, we will probably go back to a neutral weighting. I must admit that I don’t feel terribly comfortable being overweight equities at the moment,” says Bouma.

Preparing for the big sell-off

Because they hadn’t expected the equity market correction, both professional and retail investors are wary and want to reduce their equity holdings, says Klement. “The general response of my clients is that they are sceptical about what will happen next. They want to wait for a modest recovery and then sell. That means to me that the recovery will be short-lived, after which equities will trade sideways.”

Or they might even fall from there. “An equity market correction usually starts about six to nine months after the first rate hike, so I would keep my eyes open for spring or summer,” says Klement.

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