Global Markets to 15 October 2018
- Global equity markets struggle as a combination of rising US bond yields and interest rates and a looming trade war spooks global investors.
- The US benchmark 10-year Treasury bond yield reaches a seven-year high of 3.26% before dropping back to 3.14%.
- Wall Street finally wobbles with the Dow Jones Industrial Index recording its third biggest points fall ever.
- The International Monetary Fund issues warnings over the trade war, Brexit and global debt levels.
- But fundamentals remain intact and indicators suggest that this might be a buying opportunity.
- From a tactical perspective, we remain positive as far as equities are concerned, but opportunities on bond markets will emerge over time.
Financial markets have struggled significantly in recent weeks: rising US bond yields and interest rates and concerns over the escalation of trade tariffs between the United States and China have combined to put an enormous amount of stress on markets and investor confidence.
Last week’s “flash crash” was highly unsettling for investors, causing some commentators to question whether this extended bull market might actually be coming to an end. There have been some rather drastic corrections in regions such as the emerging markets and Asia in recent weeks, where peak-to-trough falls have already been in excess of 20%. However, the main focus last week was the decline on Wall Street – which had been so resilient in recent months.
Heavy falls on the Dow Jones industrial, the S&P 500 and NASDAQ indices quickly affected market sentiment globally, resulting in one of those “meltdown moments”. Warnings from the IMF about dangerous undercurrents threatening the global economy, trade war tensions, Brexit and global debt levels together constitute a worrisome backdrop for global investors.
As both global equity and bond markets struggle to comprehend whether this was a crisis point or simply a meaningful correction, it might be worth considering some of those essential principles to determine whether there are indeed grounds for concern.
In under a year, this current period of US economic expansion will have become the longest on record, begging the question as to when the next downturn will come. However, the same question could have been asked about 24 months ago, in which case one would have missed out on some remarkable returns, particularly on the US stock market, and more specifically in the technology sector.
The Federal Reserve Bank has been highly vocal in its comments about the strength of the US economy and supposed monetary tightening. But, what nobody wants right now is to see the Fed worried about its own shadow and effectively using a sledgehammer to tackle something that is not yet a reality: “rampant inflation”.
It should not be forgotten that mismanaging monetary tightening can create more problems than it solves, such as the end of an equity bull market or a nasty crash in bonds. Ostensibly, the US economy is doing very well. But perhaps not quite so well as the Fed thinks: it should be mindful of future rate hikes.
Furthermore, President Trump and Fed Chairman Jerome Powell appear to be at loggerheads over the actual speed and timing of monetary tightening, given the additional panic that it could cause. And the reality is that nobody makes money in an environment of panic.
We have now entered the US corporate earnings session for the third quarter. Although it may reveal some disappointments, the news is likely to be more animated, with many investors buying back into positive earnings. Similarly, some of those stocks that have suffered in recent days could well bounce back.
Needless to say, stock market corrections are normal after such a long bull market. All things considered, however, global valuations are still reasonable with the MSCI World Index below its 20-year average; and even Wall Street – while more expensive than a decade or so ago – is still investible.
So positive fundamentals remain intact, even if the near-term global growth outlook is troubled by uncertainties such as trade tariffs, higher interest rates, bond yields, Brexit and a global debt mountain. Arguably, last week’s rout was predictable: investors tend to go up by the stairs and come down by the elevator. Higher market volatility has created a number of nervous investors, leading to a slight correction.
There will obviously be a more meaningful change in fundamentals, such as a recession. This would affect sentiment in relation to riskier assets, such as global equities, although this is not on the immediate horizon. As far as domestic issues are concerned, Brexit remains the canary in the coal mine, with the UK Prime Minister having to do battle with both the European Union and now her own Cabinet.
Indeed, IMF Monetary and Capital Markets Director Tobias Adrian has reportedly warned against the UK leaving the EU without a deal, while trade war concerns and Brexit fears have led IMF Managing Director Christine Lagarde to downgrade the world’s economic growth forecast. However, one encouraging piece of news is that Japan’s Prime Minister, Shinzō Abe, has said that Britain would be welcomed into the Trans-Pacific Partnership trade deal with “open arms” after it leaves the EU.
The TPP is a wide-ranging trade agreement between 11 Pacific countries, including Japan, Vietnam, Malaysia, Canada, Mexico and Australia. This would clearly be a way for Britain to strike new free trade deals with many of the world’s fastest-growing economies. This follows President Trump’s assertion in July that the “US will strike a great trade deal with the UK” after Brexit.
To conclude, further volatility is likely over the coming weeks as markets adjust towards tighter monetary conditions and tariffs. But the market is expected to be higher by year-end, boosted by a positive earnings season in October, further share buybacks in November and the seasonal effect in December, more commonly known as the Santa Claus rally.
Peter Lowman is the Chief Investment Officer at Investment Quorum, a Director of the company and an integral member of our investment committee.
This article does not constitute specific advice and investors should bear in mind capital invested is not guaranteed. Investment Quorum is authorised and regulated by the Financial Conduct Authority.
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