Historically, the month of October has been a pretty challenging month for financial markets and unfortunately 2018 was no different. Over the month local markets were off about 6% and global, markets led by the S&P 500, were off close to 9%. This is causing some concern for many investors, leading to overall concerns about the direction of financial markets in the near term.
In our view we’ve seen this sell-off for four reasons.
Firstly, central banks are pushing interest rates higher, led by the Federal Reserve in the US. The US Federal Reserve has clearly articulated to financial markets that the US economy is in good shape and that it’s appropriate to increase cash rates. We’ve seen three rate rises through 2018 and we remain of the view that the US Fed will again raise cash rates another 0.25% at its December board meeting.
Secondly, higher cash rates have flowed through to bond markets. Bond yields have moved higher over the last couple of months and that’s led to some rotation between equities and bonds. Previously, this tradeoff was less evident for investors. However, we feel the rise in both the cash rate (and subsequent impact on bond markets) his is appropriate given the overall strength of the US economy.
Thirdly, while the most recent US reporting season performance has been sound, it hasn’t been stellar compared to previous reporting periods. But in our view, the sell-off in markets is a little overdone. Third quarter earnings out of the US have by and large met expectations, so we feel that valuations and the corporate earnings outlook remains relatively sound.
Finally, the ongoing trade dispute between China and the US continues to escalate and that’s creating more investor uncertainty. The US may impose a further $200 billion worth of tariffs on China as early as next month. From an investment point of view, this creates a higher level of uncertainty in financial markets. We don’t know how long the trade issues between US and China will continue and what the implications will be for long-term corporate earnings, but what is clear is that markets do not like uncertainty and this is being reflected in equity market performance.
While we don’t expect that the US/China trade dispute will rectify itself anytime soon, we do believe that the other issues are relatively normal parts of the economic and market cycle. Overall, our response has been to try and mitigate the risks. We’ve taken some measures across our portfolios to reduce our overall exposure to high-risk assets, namely equities. While we still believe that valuations warrant a reasonable exposure to equities across a broad-based portfolio, it’s all about getting the balance right.
While it’s not easy for investors when they see significant financial market moves, it’s important not to overreact to headline ‘news’. Decision need to be fundamental in nature. In our view, it’s important to look at where the market is heading in the near and long term so we can best position portfolios to take advantage of those opportunities as well as manage portfolio risk. However, as always, if you’re feeling uncertain, please talk to your financial advisor.
Piers Bolger is Chief Investment Officer at Viridian Advisory
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