Stock Market Correction May Be Coming To An End‏

Our medium-term view on the stock market has for some time been bullish, but over the past weeks we have called for a correction. This was based on a) the market being overbought, and b) we were entering an uncertain period as debt ceiling talks were going to heat up. However, following the recent decline in markets (MSCI World down 4% from the peak) the correction may be coming to an end.

1. Stocks are no longer technically overbought and we start to see signs that the market is feeling a bottom (see chart).

2. There are also signs that the logjam in the US is easing. This is a bit earlier than we expected. Key Republican leaders are showing willingness to exclude changes to Obamacare and Barack Obama and Republican leaders seem to agree on an increase of the debt ceiling until 22 November. Even if it is only a short-term deal we expect it will lift risk appetite for a while, as fiscal issues will leave the radar screen until we get closer to 22 November. Of course a deal is not done until it is signed but the odds are clearly shifting.

3. The earnings season is coming up and we expect it to be robust outside the US. Our earnings momentum indicators point higher and we believe the guidance from companies will be more positive as well. This is likely to underpin stock markets in coming weeks.

At the same time our medium-term bullish view is strengthened by continued strong data out of Europe and Japan. In Germany investment orders this week showed a rebound in capex and industrial production indicates another quarter of around 0.75% q/q German GDP growth. In Japan machine orders were also very robust, rising 10.3% y/y in August giving further evidence to the strong recovery in domestic demand.

While politics are a mess in the short term, the world is improving growth-wise. Hence once we get past the political uncertainty, markets are going to trade on the global recovery theme once again.

It is clear that the debt ceiling uncertainty will not go away if they only lift the debt ceiling for six weeks. It will come back on the radar screen again as we get closer the next deadline. Hence, even if we see relief short term, we should expect volatility to remain high into year-end.

We continue to favour buying European stocks as valuation is more attractive and we see scope for growth to surprise to the upside.

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