Finding Value in the Selloff Rubble

The recent erosion in equities turned into an all-out landslide Monday morning. Globally and in the United States, stocks are now in correction mode, with equities in emerging markets and Europe in a bear market.

The selling has extended into other asset classes, notably commodities and high yield, and has been accompanied by an abrupt spike in market volatility. According to Bloomberg data, the VIX Index, a proxy for U.S. equity market implied volatility, traded over 50 on Monday morning, the highest level since the financial crisis.

However, as I write in my new weekly commentary, “As Markets Plunge, Some Value Surfaces,” I don’t think the selloff is a prelude to another 2008-style cataclysm. Indeed, here’s the key takeaway for long-term investors: The selling has restored some value to most areas of the market.

There was no single catalyst for the brutal selloff. Rather, it appears to have been a delayed reaction to several developments. Further weakness in Chinese data added to concerns over the health of the global economy. Falling inflation expectations and the lingering potential for a monetary tightening by the Federal Reserve (Fed) also contributed to the anxiety. Meanwhile, it could be argued that the spike in volatility is a somewhat overdue response to slower economic growth and deteriorating credit market conditions.

That said, while I believe global growth will remain below trend, the evidence suggests that the global economy is not on the cusp of another recession. Global economic measures, while admittedly suffering from relatively short histories, are suggesting that growth should remain positive. Both the Global PMI and Global Services PMI are comfortably in expansion territory, Bloomberg data shows.

On a regional basis, U.S. leading indicators look solid, if uninspiring, and in Europe, recent manufacturing, sentiment and credit surveys are all suggesting further stabilization in growth. In addition, lower oil prices and lower rates should both help stabilize growth.

Assuming the global economy continues to expand, the recent selling has returned some value to many financial assets. Though stocks pared some losses by midday Monday, valuations for most assets are a long way from the tops typically seen prior to bear markets, according to my analysis using Bloomberg data.

Developed market stocks, as measured by the MSCI World Index, are now trading at roughly 2x book value, about 10% below their 20-year average and roughly 25% below their peak valuation in 2007. One example of a developed market region that has been particularly hard hit, probably excessively, is Europe. European equities, as represented by the S&P Europe 350 Index, are now trading at less than 12x forward earnings and 1.3x book value. The selling may be overdone, considering that investors may be exaggerating Europe’s exposure to China.

Elsewhere, the MSCI Emerging Markets Index, which has been particularly hard hit, is trading at less than 12x earnings and barely 1.25x book, a level last seen during the lows in early 2009.

The selling has even restored some value to U.S. equities. The S&P 500 is now trading for less than 15x forward earnings, and the Dow Industrials is now selling for barely 13x next year’s earnings.

There’s a similar story in credit. Take U.S. high yield, one of the hardest hit segments. The asset class, represented by the Markit iBoxx USD Liquid High Yield Index, has seen spreads relative to Treasuries widen sharply, despite the fact that defaults remain well below historical levels.

The bottom line: While higher volatility is here for the foreseeable future, the selloff has created a number of potential opportunities for investors with longer-term holding periods.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

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