Volatility reprise
Earlier this year, Betterment, an online investment company based in New York, conducted a survey of 2,000 people to gauge their impressions of equity market performance. Of those Americans polled, 48% said they thought the stock market had failed to rise in ten years, while 18% said they thought it had gone down. Most were therefore wrong.
“From the previous peak, on October 9, 2007, the stock market is up 137%. Any way you slice and dice this one, the market definitely [isn’t] flat or down over the past decade,” reported EdgePoint, co-manager of the St. James’s Place Global Equity and Global Growth funds, in its quarterly review last week. “If an investor simply bought [the market] in 1980 and held it these past 38 years through all the market drama, they would have made 11.8% a year.”
Unfortunately, many investors have forgotten what volatility feels like – and are prone to panic during the falls. Last week, amid meteorological storms and floods, they were served up a healthy reminder, as the S&P 500 slid to its largest weekly fall in six months, clocking some 4.1% of paper losses. It pulled others in for the ride, too: the STOXX Europe 600 experienced its worst day in four months; the FTSE 100 fell below 7,000 and into correction territory (i.e. 10% or more below its previous high); and the TOPIX in Japan suffered its worst single-day drop since March. The MSCI World Index finished down some 6%.
Early signals this week offered only mixed messages as to whether this trend might persist but, while the impact of investor nerves was fairly indiscriminate, some sectors have been worse affected than others. The most apparent cause of the falls was a spike in the yield on the 10-year US Treasury (often dubbed ‘the most important number in the world’). The yield on US government debt rose last week to a seven-year high. Behind the shift were investor fears that the Federal Reserve’s bullish confidence about the US economic outlook makes it likely to proceed with planned interest rate rises.
That, in turn, hit equity markets, not least because bonds had begun to offer more competitive yields, but also due to fears that the Fed’s actions might end up putting the brakes on the current run of US economic growth. Donald Trump was quick to lament the direction of travel: “I think the Fed is making a mistake. They’re so tight. I think the Fed has gone crazy.” (He might have been happier that it pushed down the value of the dollar.) Yet we have been here before. As recently as February this year, a similar spike in Treasury yields caused a 10% plunge in the S&P 500; on that occasion, the slide was soon reversed.
Friday offered short-term market speculators a reminder that the real economy always matters on markets, as third-quarter earnings got under way. JPMorgan Chase, the US bank, was the first major company to report; it beat expectations, benefiting from growth in its consumer banking division. Wall Street analysts also predict healthy earnings for US blue chips more broadly, with a consensus forecast of a 19% rise in earnings per share. Like so many US businesses, JPMorgan Chase also continues to benefit from Donald Trump’s tax-cuts bill.
Jamie Dimon, the bank’s respected chief executive, told the press that the US economy remains strong “despite increasing economic and geopolitical uncertainties”. He also said that the 10-year yield would rise to 4% – possibly even 5%. Since the Treasury yield acts as a proxy (or guide) for bond yields more broadly, that kind of rise would offer bond investors a more attractive universe in which to to invest.
But the continued resilience of the global economy may be the most important trend for investors to cling to, even as geopolitical and trade tensions continue to mount. When the US has imposed tariffs on 50% of imports from China, and China has now imposed tariffs on 68% of imports from the US, such trends are all the more comforting, even if concerns remain that the impact of the tax-cuts package will peter out in 2019.
“Investors should be wary of being distracted by the cacophony of noise from politics – Italy, Brexit or the ups and downs of the Trump White House,” said David Riley, Chief Investment Strategist at BlueBay Asset Management, co-manager of the St. James’s Place Strategic Income fund. “That’s not to say political developments are unimportant – politics is more important than ever – but investors should not lose sight of the fundamental drivers of future returns – growth, corporate earnings, and valuations. Global growth is strong and it is not just a US story. The European economy is running above trend as unemployment is falling and corporate fundamentals are improving. The most important driver into the end of the year in asset markets will be relative growth performance of the US compared to Europe and the rest of the world.”
Brexit–Budget play-off
There was also good news in the UK, as the latest figures suggested positive economic momentum in the third quarter as a whole (despite sluggishness in August). This offered some encouragement, even if growth in 2018 may still prove to be subdued.
“Our forecast is for growth of 1.3% [this year], which would be the weakest annual expansion since the financial crisis,” Capital Economics said in a report last week.
Meanwhile, in a new research paper, the IMF criticised the UK for the state of its public finances, which is among the worst in the developed world. While most countries have assets in excess of their liabilities, the UK sold off many of its assets in the privatisations under Margaret Thatcher’s administration, and currently has net liabilities of more than ￡2 trillion, which is more than 100% of GDP. The fund also warned that the UK is heavily exposed to inflation due to the index-linked nature of much of its debt, and advised allowing for greater public spending and taxation to cushion the fallout from a hard Brexit.
On the latter, those favouring a deal could feel some positive momentum last week, as increasingly hopeful noises from both London and Brussels suggested the beginnings of a deal might be confirmed at this week’s meeting of the European Council. Yet that momentum reversed over the weekend, as David Davis encouraged Cabinet members to vote against Theresa May’s proposed deal. More importantly, talks between Dominic Raab and Michel Barnier broke down over Northern Ireland backstop arrangements, all but ruling out a deal being agreed at this week’s European Council meeting.
In theory, of course, the Budget was brought forward to avoid being tarred by the politics of Brexit. Last week, however, reality stepped in, as the DUP threatened to vote against the Budget if the integrity of the UK was compromised by the Brexit deal. Other grumblers were muttering similar threats.
The chancellor now has quite a job to present a Budget that angers neither Brexiteers nor Remainers, seeks to address the UK’s fiscal deficit and also signals the imminent end of austerity, while keeping an eye on any possible general election.
In this light, it is perhaps understandable that the government said last week that there is, in fact, no clear consensus for changing tax relief on pensions, despite the Treasury report last year suggesting it was ripe for reform. Steve Webb, former pensions minister, told the press that some changes within the current structure were still feasible, however.
BlueBay and EdgePoint are fund managers for St. James’s Place.
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