PA ANALYSIS: Preparing for a market correction – hedge or diversify?

The bulls and bears are out in force, divided over the prospect of a market correction in the near future, but is it wise to hedge equity exposure or is good old-fashioned diversification the way to go?

PA ANALYSIS: Preparing for a market correction – hedge or diversify?

Last week Charles Stanley set itself firmly in the bull camp by boldly declaring “the bears are wrong”. It claimed, based on its own data, that the strength of corporate earnings in the US, Europe and Japan would keep the bull market thriving, despite the recent flare up in international relations between the US and North Korea.

The wealth manager’s data found 76% of S&P 500 companies that reported in Q2 beat analysts’ estimates, with aggregate earnings beating them by as much as 5%. Japan meanwhile, delivered 43% earnings growth year-on-year. 

The S&P 500 has skyrocketed in recent weeks. Last Wednesday the index set a record of 15 days without a closing move bigger than 0.3% in either direction – this is the longest flat run for 90 years.

As a result, Charles Stanley is overweight global equities, but others are playing it safer for fear that a correction is overdue.

"Whether or not investors believe a correction is imminent, it would not hurt to avoid complacency and be aware of the options available to make the portfolio resilient to shocks."

According to Bank of America Merrill Lynch’s latest fund manager survey, global fund managers are becoming increasingly bearish on corporate profits.

The survey found a net 33% of managers thought corporate profits would increase over the next year, falling eight percentage points (ppts) from last month, and down 25ppts from January – the lowest level since November 2005.

Michael Hartnett, chief investment strategist at BofAML, says this presents a “warning sign for equities over bonds, high yield over investment grade, and cyclical sectors over defensive ones”.

Christian Preussner, managing director at JP Morgan Asset Management, says shares have been “climbing a wall of worry since 2009” and while equity valuations are arguably only at slightly elevated levels, and tend to be a poor predictor of market sell-offs, there is still a fear that a correction is coming.


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