Global Correction

Should investors be worried about a global equity market correction?

The global market has performed well since the GFC, and investors worry that at some point the party must come to an end.

In many developed markets, equities have produced solid returns since March 2009, which was the bottom of the market crash during the GFC. This rally can be justified in part, by an improvement in company earnings during the economic recovery. But it was also fuelled by low global interest rates, which have motivated investors to shift investment flows away from cash and fixed income towards equities. As a result of these factors, equity valuations have slowly been rising and today they sit slightly above long term averages. In some markets, such as the United States, and parts of Europe, valuations are well above long term averages. This may be a sign that investors in those markets have become overly enthusiastic about equities.

Cashflows

Morningstar research data on global net asset flows shows investors have pumped US$1.7 trillion dollars into equity funds since January 2013 (see Figure 1). These flows appear to have chased the improving performance of equity markets over that same period.

When valuations have historically been at or above current levels, the probability of a correction has been higher than normal. These losses will be recovered over time, such that a global equity portfolio is likely to outperform cash, fixed income and inflation over the next 10 years. However, investors should offset this downside risk by holding a globally diversified equity portfolio, with minimal home equity bias or tilts towards markets with recent strong performance.

Figure 1 – Global net asset flows into equities vs MSCI World annual total return

Notes: Asset flows represent Morningstar category Worldwide OE & MM ex FOF ex Feeder, 12 month rolling sum of flows in USD. Returns represent the 12 month total return of the MSCI World Index in USD.

Source: Morningstar and Thomson Reuters.