Rising US bond yields spark volatility breakout
Synchronised declines in global equity markets may help stockpickers
October’s sharp declines in equity markets are being attributed to rising US bond yields. However, the surge in volatility is similar to that seen in January and raises questions about an underlying weakness in equity market depth rather than any radical change in fundamentals. It was hardly a secret that bond yields were likely to rise further over time given the strength of the US economy. Furthermore, a quarter-point increase in US 10y rates to 3.25% is not an especially large move. Recent increases in the US 2y rate perhaps went against the grain of Powell’s August comments but again were not especially noteworthy. We believe investors should first ensure that portfolios are appropriately positioned from a risk perspective, given the likelihood of a higher volatility trading environment. Second, investors should be actively looking for securities which have been unfairly discounted in what has been an indiscriminate sell-off. However, we do not feel it is time to change our cautious stance on developed equity markets in general.
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Brexit: UK Risk premium likely to remain in place
Investors face continued UK uncertainty and polarising outcomes post-Salzburg
The unproductive summit of European leaders in Salzburg this week has highlighted the lack of substantive progress on finding any solution to an exit agreement for the UK which will satisfy the EU, Ireland, Northern Ireland, UK government and UK parliament. Most importantly the declaration by EU Council President Tusk that the UK’s “Chequers” plan will undermine the single market highlights an objection in principle to the UK’s initiative for a free trade area in goods during any Brexit transition period. This principles-based roadblock suggests that tinkering at the edges – such as customs checks in the Irish Sea are irrelevant details. We see elevated political risk in the UK, potentially polarising the outcome between a hard Brexit and no Brexit. Investors will also need to consider the increased risk of a populist UK government.
Read more...2018 Earnings forecasts stable over the summer
Only marginal declines in EMs suggest that fears of an imminent crisis are overblown
There is a relatively strong correlation between the direction of earnings forecasts and the short-term relative performance of equity markets. Over the last 12m, US markets have outperformed peers as Trump’s corporate tax reductions and fiscal stimulus have provided a tailwind for US earnings. In the UK, although weighted earnings forecasts have risen, UK stocks have trailed behind, impacted in our view by the negative domestic sentiment in terms of Brexit. Similarly in continental Europe, market sentiment has been impacted by international and domestic political events. Intriguingly, the median emerging market forecast has only fallen by 2% since the Q1 peak, similar to the UK and Europe, suggesting fears of an imminent crisis are not at present feeding through to the corporate sector.
Read more...Choose your narrative with care for 2019
Trade, politics or tighter US monetary policy? One may have a light at the end of the tunnel
In the 10 years since the global financial crisis of 2007-2008 there has been a perennial fear that the withdrawal of central bank support would lead to a collapse in asset values, which had been artificially inflated by ultra-low interest rates and asset purchases. With equity markets outside the US now having fallen by 13% in US dollar terms since the peak in Q1 18 as US interest rates have risen, it is very easy to become convinced this is the start of something bigger. While experience is in general an advantage, investors should beware of the risk of being too quick to make emotive links with the run-up to the 2008 financial crisis and emerging market crises of the 1990s. Notwithstanding the recent market declines, when we look ahead into 2019 we can see scenarios which imply a continued, albeit slower, global GDP and profits expansion - and a pause or slowing in Fed rate increases.
Read more...Turkey:When risks collide
US sanctions on Turkey overlay political risk on economic fragility
Turkey has long been the beneficiary of substantial US dollar funding. However the Erdogan administration is now on the receiving end of US sanctions, having failed to agree to the release of a US pastor held under house arrest in Turkey. A 28% fall in the Turkish Lira last week has highlighted the risks to a corporate sector highly reliant on dollar borrowing. In addition, solutions now appear down to geopolitics rather than domestic economic policy. Given the already entrenched positions of both the US and Turkey, resolution in the short-term appears unlikely in our view. For investors not exposed to Turkey, the lessons are twofold. First, economic fundamentals do now “matter” as the era of cheap and plentiful US dollars draws to close. Second, the rise of populism on both sides of the Atlantic continues to translate elevated political risk into actual investment outcomes.
Read more...Earnings estimates: Marginal declines could point to trouble ahead
Regions outside US now showing modest downgrades
Outside the US, most equity sectors have suffered modest downward revisions to 2018 earnings forecasts over the past four weeks. Within the US, 2018 earnings forecasts are effectively unchanged over the same period. It is too early in our view to be certain that this loss of momentum in non-US estimates is the start of a downtrend but it is consistent with the recent sharp declines in industrial commodities. The good news for 2018 – such as US tax cuts and continuing Eurozone expansion was always in our view a H1 phenomenon. The more challenging narratives such as rising US interest rates were in contrast likely to endure for longer. Furthermore, trade war uncertainty has reached a new peak.
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