As you may have observed there were significant downward movements in US equities yesterday and markets have opened negatively this morning in most regions. As we have alluded to in recent communications, the threat of a pull-back in stock markets has been hovering over us for some time and the catalyst was one that we had been watching closely. The initial source of worry was the stronger-than-expected US employment and wage growth data at the end of last week. While this sparked concerns of higher inflation and, consequently, more interest rate increases than anticipated, the driver of much of the volatility in markets was largely due to the increased volume of trading in Exchange Traded Funds (ETF) and by high-frequency traders, which exacerbate severe market movements. As ETFs make up nearly 20% of US trading volumes markets can move very quickly on these sort of unusual movements.
Valuations in many regions have been higher than average after some excellent growth in recent years, but these are supported – especially in the US – by exceptionally strong economic growth and corporate earnings figures. The wage growth data that initiated this move in markets is stimulative for many areas of the economy and strengthens consumer demand across the board. Together with impending tax cuts in the US, which could be give companies a further boost in the next couple of years, the outlook is positive on a fundamental level.
At time of writing, the indicators of future stock market movements are showing that prices are already starting to stabilise and even rise in some areas, which shows the confidence of the investment community at the moment, even after heavy falls. Clearly some aspects of our portfolios are more sensitive to falls than others, the higher sensitivity areas being Japan and other parts of Asia, but the protection that we hold in the form of property, short-dated bonds and ‘absolute return’ funds will help to mitigate equity falls in these times. Our Balanced and Conservative models are also currently holding a lower level of overall equity in relation to some of our previous portfolios. Interestingly, the sovereign bonds that would be badly affected by significant rises in interest rates are currently rallying, potentially showing that the bond market does not believe a significant Federal Reserve policy change is likely.
Overall, earnings growth (corporate earnings are currently growing at around 11% year-on-year), employment and GDP growth remain robust and are improving almost without exception. In long-term rising markets sell-offs are not unusual and are often healthy for continued strength to be maintained, but we do anticipate more of these as we move further into a rising interest rate environment. Markets typically rise in times when rates are rising as it signals that the economy is in good health and we see this situation as no exception to this. We are mindful that some assets such as longer-dated bonds, real estate and some other interest-rate linked assets can suffer and are investing accordingly. As we have alluded to recently, we do not foresee a continuation of the high overall growth in portfolios of the recent past, but would expect lower, solid returns, with a higher degree of volatility along the way.
In conclusion, we have anticipated a move of this kind and are well positioned for this in Cautious to Balanced models and don’t recommend any changes. More aggressive investors may wish to discuss their circumstances with their adviser to ensure that continued higher risk remains appropriate.
As ever, please do not hesitate to contact me, or your adviser if you would like to discuss any aspect of this in further detail.
Tom Sparke IMC CertPFS (DM)
GDIM: Discretionary Fund Managers