While fears about China policy tightening and increased regulation have contributed to the correction in stock prices, it is the issue of sovereign debt that seems to have been the key focus, says Peter Oppenheimer, chief European equity strategist at Goldman Sachs. These concerns, in particular, may now be overdone.
Firstly, although debt sustainability ratios look strained across Europe, we believe they are manageable for the most part, while liquidity fears should be allayed by the raft of support measures from the European Central Bank and the International Monetary Fund.
Furthermore, several European countries have moved aggressively to tackle debt levels through fiscal austerity cuts.
Historical examples of debt reduction across countries from the Organisation for Economic Co-operation and Development over 35 years suggests that countries’ stock markets generally do well as a result of fiscal contraction, particularly if the bulk of the adjustment is focused on expenditure cuts.
In the UK, there have been three periods over the past 40 years when the deficit has been cut significantly: in 1977, propelled by the IMF loan requirements; in the early 1980s with the new Thatcher government; and between 1995 and 1998 when spending cuts moved a deficit into surplus.
On all three occasions UK equities outperformed the world market, experiencing an overall re-rating over the following couple of years.