Why have the markets fallen?
Social Media celebrated the end of January, after a month that felt like a year. It also heralded in the start of results and outlook season
The investment and bond markets, however, ended an extended period of growth with a return to some sharp falls. Here’s our view as to why;
- For weeks, stock markets and bond yields had been rising steadily
- Bond yields (profit when selling, increased cost when buying) have been increasing around the world due to a mixture of better prospects for GDP growth and higher expectations of inflation
- Ten-year gilts jumped 13 basis points to 1.57% last week; they started the year at 1.19
- The 10-year US treasury yield finished 18bps higher for the week at 2.84%; it started the year at 2.41%
Why this is important;
- Rising yields mean that borrowing is getting more expensive for companies, which can flatten growth and profit
State of the Nation
- The net number of jobs added in the US (excluding farm workers) – came in at 200,000 for January, 20,000 more than forecast
- US Wage growth, also released on Friday was 2.9% higher than a year ago (30 basis points ahead of expectations)
- Historic tax cuts and the Jobs Act Reform, essentially saw corporation tax cut from 35% to 21%
But, these are good things?
- Rather than focusing on the first effect of stronger US jobs growth, investors appeared to fixate on a potential future downturn that may be sparked by faster and steeper interest rate hikes from an attempt by the Federal Reserve to curtail rampant inflation driven by higher wages
- To stem an over-heating economy, Central Banks could increase interest rates faster and steeper than already planned and priced in
- Historically, Economists and fund managers take the view that sharply rising inflation creates recessionary environments
- During these cycles, fund managers operate a ‘risk off’ process, where they sell off holdings to maintain higher cash positions, to hedge against short-term issues
So, what should investors do?
- Expect more volatility during 2018, with further falls in equity and bond markets in the immediate term
- Maintain a diverse portfolio and maintain cash reserves for short-term / expected expenditure
There is a lot of commentary and data passing across my desk and taking stock of the build up to the current volatility, the consensus views from fund managers looks like this;
- In the short-term fund managers have curbed some equity holdings, but generally remain ‘overweight’ in the asset class
- The correlation of bond yields and equity prices has long been established. Even if rates rose one or two more times than the three forecast by the Fed and the market, equities can recover.
- The US economy looks strong, as does Europe and the East
- It is also important to note that global monetary conditions are barely tightening at all as yet. Of the 21 central banks monitored, only four have raised rates over the last 12 months, while five are still cutting
- Most are simply sitting on their hands: the Bank of England (BoE) is one of them. UK inflation has plateaued at roughly 3% since August (it is forecast to remain flat when the next figure is released next Tuesday)
- UK consumers have had a tough time of it and they’ve gobbled up masses of credit in recent years. The BoE will be reluctant to raise rates to curb inflation when in doing so it risks a solid portion of households being unable to repay what they owe
- If a recession occurred in the US, it would have less of an impact on equities compared to bonds
All of the above is short-term outlook and will, therefore change as and when fiscal policy makers make their moves.
Maintaining a cautionary approach in these cycles is prudent and understanding the overall ‘risk profile’ of your savings is a must
If you are investing for the longer-term, do not panic, but make sure you review and invest with the economic backdrop in mind
*stock market falls are a natural phenomenon, I have experienced a few in my career, some worse than others. Review – Consider – Carry on