While we don’t know when the equity market’s recent volatility will settle down, it’s important to consider the big-picture, fundamental backdrop for the market, and not get caught up in short-term sentiment swings, according to Franklin Templeton’s head of equities, Stephen Dover. And, he believes the fundamental backdrop still looks solid.
Recently, we’ve seen equity markets pull back amid concerns that rising rates, inflation and slower growth could erode profitability for companies.
On Monday, February 5th, the US equity market experienced a sudden bout of volatility. The Dow Jones Industrial Average logged its largest-ever point decline to close down just over 1,175 points, although it had briefly dropped nearly 1,600 points during the day. It was the index’s largest one-day percentage decline since August 2011. The ripples were felt around the world as Asian and European equity markets followed suit on Tuesday, February 6.
The suddenness of the market decline has left some market observers searching for an explanation, with one being a recognition that the era of cheap money globally appears to be ending.
However, equity investors have had good returns for many years now, so we view a market correction as healthy. When you consider the markets have had a relatively strong, unprecedented rise the past couple of years, market corrections can serve as an opportunity to improve valuations so it’s not quite as expensive to buy stocks. This helps to make new portfolio allocations more efficient.
Investors should not confuse the market for the economy. We have seen real, solid, economic growth globally. Companies that have low levels of debt, good earnings visibility, pricing power and positive cash flow should be able to do well even in an environment of tighter monetary policy and rising interest rates.
It’s important to stress that while markets can be volatile in the near term, over the long term, they reflect the underlying fundamentals of companies and countries. In our view, long-term structural growth drivers are still in place, and a slight rise in interest rates or inflation should not have a significant detrimental impact. Consumer spending, infrastructure, technological innovation/adaptation are the long-term structural drivers of global growth, along with healthcare innovation.