Speaking on the current market volatility, Valentijn van Nieuwenhuijzen, Head of Multi-Asset at NN Investment Partners, says: "In the aftermath of the shocking devaluation of the Chinese currency, markets remained focussed on fragility in the broader emerging market complex. Especially since the ripple effect of increased uncertainty over the China outlook is not only impacting many other emerging market economies, but also a key driver of supply-demand expectations in commodity markets. Moreover, many other parts in the global economic system are impacted by this. Especially asset prices related to the energy or materials sectors or of export oriented regions in developed markets, like Germany or Japan, remain very sensitive to shifting expectations about the future of China.
"At this point we have a clear example of a shift in causality between fundamentals and markets, whereby the economic outlook could become a function of current market behaviour rather than the other way around. In such an economic ecology it is very difficult to determine when a bout of market volatility will calm down. The future path of the market will partially be determined by the extent to which current feedback loops from markets into the real economy change the growth outlook.
"Next to being complex and confusing, this underscores the importance of analysing the market itself and the behaviour of its participants. With respect to the EM and commodity volatility in recent weeks it is noteworthy right now how large the consensus is, amongst active players in the markets, to be negative on these asset classes. Investor surveys show close to record underweight in emerging market (EM) equities, commodities and energy related sectors. Generally, these type of indicators can provide a contrarian signal, but how lasting a possible rebound could be is difficult to assess as some of the China/EM ripple effects into the underlying fundamentals can easily come back to haunt markets in the medium-term.
"For us this environment justifies a more cautious asset allocation stance and therefore we have reduced our exposure to global equity, real estate and credit markets in recent weeks, while already having a cautious stance on commodities for longer. Also, we have upgraded government bonds again after being much more cautious on them during most of the second quarter. At the same time, we appreciate that the market behaviour in recent days - broad based risk-aversion, the sharp correction in Chinese/global equities and oil prices, high volatility in foreign exchange markets - is now so extreme that many of these assets have now reached “over-sold” levels and a technical bounce cannot be excluded. As a result we remain neutral on equities and real estate rather already moving these asset classes to an underweight. The most defensive tilts in our allocation stance remain focussed on the centre of the storm with firm underweights in the EM region in both equity and bond space, credit markets and commodities."
