Why Stock Markets Went Wild Last Week!

Major averages ended the week with their steepest losses since … well since March earlier this year. The Dow ended the week down 4.4%, the S&P fell 4.3% and NASDAQ lost 3.5%. Shares across Europe fell by almost 5%. In China, Hong Kong and Japan markets were off by anything from 2.5% to 4.6%. There was some suggestion of a reprieve at the end of week. It remains to be seen if this is a recovery or just a dead cat bounce. 

So what sparked the collapse in share prices. There is some suggestion of profit taking amongst our Empires of the Cloud. Amazon and Square particularly were badly hit. Tech stocks in general were punished, a hint of China added to the pain. European stocks were lower on fears over Brexit and Italian bond spreads.

Major concerns developed as US ten year bond yields touched 3.25%. The Fed is intent on a further rate rise later this year with more planned for 2019. The Fed is right to act. US growth will be over 3% this year, inflation is already at 2.7%. Employment trends remain positive, with the prospect of earnings set to rise. The Amazon decision on the $15 dollar an hour minimum wage added to the excitement. The US will face the inherent problems of Trump’s economic policy. Tax cuts and spending plans will add to government debt and deficits. Expansion in the US economy will enhance the balance of payments deficit, despite the impact of the misguided tariff policy. Inflation is set to rise further in Uncle Sam’s backyard. 

The Fed is acting ahead of the curve to push up short rates now. The yield curve is reacting to present a real rate of return over the bond yield horizon. Just weeks ago markets were fretting over the prospects of an inverted yield curve, an alleged harbinger of doom. Now bond yields are normalising, the equity markets should relax. The fundamentals remain in place for a strong growth in revenues, earnings, profits and dividends. 

We see 3.5% as the ten year bond yield in the short term and 4.5% as the norm. Equities should rally as bond prices slump.

Not everyone is pleased. Trump reiterated his frustrations with monetary policy. “Crazy” “loco” and “out of control” the overall perspective on Fed policy. “I think I know about it better than they do” the President stated with a usual degree of modesty. “I will not fire him” the President assured markets in a reference to Jerome Powell, Chairman of the Fed. Its not clear if the President could. Prospects would be seriously diminished if the Republicans lose majority in the house following the mid terms .

So what happens next?

The Fed will hold the line on planned rate rises. Ten year bond yields will move higher at the expense of bond prices. The fundamentals remain in place for a rally in equity prices in the USA. We expect the strong rhetoric against China will fade after the mid terms. Trump will meet Xi, victory declared, peace will be break out along with the equity rally in South East Asia. In Europe the Brexit enigma will continue to overhang markets well into 2019.  

? 2018 John Ashcroft, Economics, Strategy and Social Media, experience worth sharing.

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