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Against the Tide: Get into the comfort zone

With the recent sell-off behind them, Japanese and eurozone equities look to be more attractive growth or defensive prospects than US stocks.

In May, the combination of strong global equity markets and low volatility that had endured for three years came to an abrupt halt. With nervousness in financial markets continuing, it pays to take a step back and consider the performance of the equity markets in the context of the last 18 months.

The markets that went up most in 2005 have suffered the biggest peak-to-trough correction this year. And although higher-risk assets such as emerging market equities fell most from their peak (by 24%), safe-haven assets like gold declined almost as much (22%) and yet lower-quality corporate credits barely wobbled. Now most regions have recovered sufficiently from their lows to bring year-to-date performance close to the flat line.

Globally, what triggered the sell-off was the recent acceleration in US core inflation above the Federal Reserve’s “comfort zone”. In just a few weeks, investor expectations have shifted from a “pause” on interest rates to a widespread view that there will another 25 basis point increase in August.

But the relatively stiff fall in Japanese equity prices in the sell-off was a result of country-specific factors. Since the beginning of the new fiscal year in April, the Bank of Japan has been aggressively draining liquidity, with the end of its policy of “quantitative easing”.

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