The bull market has suffered noticable damage

Equity and oil prices have finally started to rebound, encouraged by policy comments from the heads of Europe's and Japan's central banks last week. We used the relative calm to assess the fallout of the recent turmoil and found that the global bull regime has suffered noticeable damage. Markets are thus likely to remain stuck in volatile trading ranges for a considerable time. We reserve the option to act in a countercyclical manner, and sell into further significant strength.

Please find below the market comment by Mikio Kumada, CIIA, Global Strategist LGT Capital Partners:

- Market comment (PDF)

- Photo Mikio Kumada (JPG)

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The bull market has suffered noticable damage

Equity and oil prices have finally started to rebound, encouraged by policy comments from the heads of Europe's and Japan's central banks last week. We used the relative calm to assess the fallout of the recent turmoil and found that the global bull regime has suffered noticeable damage. Markets are thus likely to remain stuck in volatile trading ranges for a considerable time. We reserve the option to act in a countercyclical manner, and sell into further significant strength.

European Central Bank President Mario Draghi last Thursday reassured investors that the ECB had the "determination, and the willingness and the capacity" to act, and deploy "plenty of instruments" to counter slowing inflation. The same message was repeated by Bank of Japan Governor Haruhiko Kuroda, who added that there were "no limits" with respect to the BOJ's potential policy tools and asset-purchases.

The markets responded accordingly, with Japan's Topix and the EuroStoxx leading with gains of 7.6% and 5.3% since the respective comments were made. By comparison, the S&P 500 is up by about 1%, while rallies in Russia and Eastern Europe bolstered the MSCI Emerging Markets by 4%. Crude oil prices are trading about 10% higher. Only China's relatively segregated domestic indices of Shanghai and Shenzhen continued to slide to new lows.

So far, so good - but the overarching question now is whether the recent turmoil represented just another correction in an aging, but intact bull market, or the first phase of a new, more difficult and volatile market regime, or even a bear market. In the former case, panic selloffs need to be bought, while in the latter, recoveries provide an opportunity to reduce risk.

We are not in the bearish camp yet

That said, we continue to harbor reservations to fully subscribe to an outright bearish case. The global economy is still growing moderately, the data flow and monetary policy setting remain constructive overall, corporate earnings seem to be holding up reasonably well (see PDF page 2), and there are no tangible news or facts that point to the emergence of new highimpact risks. At the same time, the recent selloff had not reached panic levels in the developed markets. For example, the S&P 500 Volatility Index last week peaked at only about half the level it reached during the August correction. On the other hand, the rebound since last Thursday has also not gone far enough either. In other words, the time has not yet come for contrarian, countercyclical equity purchases, or sales.

Recent turmoil has caused significant damage

In the bigger picture, however, we have now seen two major international selloffs within just six months, triggered by Chinese stock market and currency problems, and simultaneously plunging international energy prices. These disruptions caused significant structural damage in the markets, potentially turning fundamentally unjustifiable fears into self-fulfilling prophesies that end up hurting the real economy. Central bank interventions, meanwhile, action can only be truly effective when they are decisive, preemptive, and unexpected. Unfortunately, neither Mr. Draghi nor Mr. Kuroda implied actions of such magnitude when they spoke last week. Rather, markets appear to be rallying on reheated old hopes, not actual policy news, and central banks now may have fallen behind the curve.

Thus, at the very least, we believe that market volatility is here to stay, and the chances for a full restoration of the bullish regime are now smaller than they were after last August's correction. Going forward, markets will probably move broadly sideways in a volatile, news-sensitive fashion - favoring countercyclical, contrarian tactical investment strategies. In short, our view of the global markets has become more cautious, although we are not yet ready to call out a bear market.

Corporate results may not be good enough for a continued bull market

The tables below (see PDF page 2) summarize the current status of the global reporting season for the fourth quarter of 2015, based on the MSCI World All-Countries Index. About one tenth of its members have reported earnings, with most being US companies. Global corporate revenue and earnings per share were close to unchanged in Q4/2015 year-over-year. The consensus had projected a rather significant drop in earnings, so the outcome is not bad.

Furthermore, the picture could further improve in coming days and weeks as European and Japanese results trickle in. That is because, compared to the US and the EM, companies from these territories are less negatively exposed to the slump in energy and commodity prices, while their respective domestic economic recoveries are younger than the US cycle.

Expectations for the coming years now seem rather high

However, the real problem is that the overall consensus expectations for the next two years seem too high. The consensus forecasts for the MSCI All-Countries' EPS at present imply growth rates of 11% to 12% for the next two years. These numbers assume earnings growth will remain relatively high in the developed markets, and rebound strongly in the emerging ones (see table PDF page 4).

But such levels of profit growth seem questionable against the current background of an intensifying commodity price slump and a continued weakness in the EM. Such medium-term growth rates would require the economies to start delivering significant positive surprises in the near future. Alternatively, we would need to see strong monetary or energy policy interventions - such as a complete reversal of the US Federal Reserve's interest rate hike plans, or credible decisions by oil-producing countries to reverse their supply-friendly policies, and sharply cut production.

Given the current uncertainties and the elevated medium-term forecasts, the current earnings data will probably not suffice to help fully restore a bull market. After all, a healthy, bullish regime is typically accompanied by rather low medium-term expectations, combined with a high, but often ignored, level of current earnings growth - which is the exact opposite of the current situation.

Please find additional graphs and charts in the PDF on pages 2 - 4.

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