News Column

As investor Carl Icahn advises caution on US stocks, should we fear a market correction?

July 14, 2014

YES Julian Jessop There are at least three good reasons to be cautious. First, valuations are looking increasingly stretched in the US, particularly based on classic metrics such as Robert Shiller's cyclically-adjusted price-earnings ratio (CAPE). Second, the low levels of market volatility might be fuelling complacency. It certainly feels like "the calm before the storm" to me. Third, there are plenty of plausible catalysts for a correction, including geopolitical risks, renewed worries about China and the Eurozone, and an earlier tightening of monetary policy in the US. Indeed, we would put a less dovish Federal Reserve at the top of our list of likely triggers. That said, there are also good reasons to expect any correction to be temporary rather than the start of an extended bear market. In particular, the equilibrium level of the CAPE is probably higher than in the past, and the neutral level of US interest rates lower. But the ride is set to become much bumpier. Julian Jessop is chief global economist at Capital Economics.

NO Kerry Craig The latest news on bank stocks and developments in Portugal isn't a resumption of a banking crisis, and investors shouldn't take this as a sign of contagion. Markets don't move in a linear fashion, and investors shouldn't rush to the exit based on the latest negative headline in the papers. The ingredients are in place for stronger European earnings, which should enable further gains and justify the existing ones. Likewise, earnings growth in the US and other developed economies should support markets, meaning stocks still have some room to rise. This is the rally that everyone loves to hate, because investors know that the stellar run in developed market equities cannot last forever, and valuations are no longer "cheap". But even with the prospect of short-term turbulence, we think the environment of accommodative monetary policy, an expanding global economy, and restrained inflation justifies a modest preference for riskier assets. Kerry Craig is global market strategist at JP Morgan Asset Management.

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Source: City A.M. (UK)

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