October is turning out to be the worst month for US and Global equities since the 2008 financial crisis reigniting fears that the longest bull market has come to an abrupt halt. This downturn despite data showing the US economy is still growing at a robust 3.5% annualised rate in the third quarter.
The US S&P 500 finished last week 10% down from the September 21 all-time high.
- Central Banks: Most big central banks will continue to wind-down crisis-era stimulus programmes (despite signs that economies outside the US are slowing).The US Federal Reserve (Central Bank) is ‘normalising’ interest rate policy having raised the key ‘Fed Funds’ rate 3 times so far this year to the 2.0%-2.25% band with a further 0.25% rise expected in December and 3 more 0.25% rises expected next year (see Note 1).
- Bond Yields: The bond market reflects longer term interest rates. Higher yields mean It is more expensive for companies to borrow money i.e. lower corporate profitability. Furthermore, higher yields make bonds a more attractive investment (at the expense of stock investment).
- At the start of 2018 the key US Treasury Government Bond was yielding 2.50%. Two weeks ago this rose to above 3.20% and scared the stock market for the reasons above. Ironically, when stocks fall, as they have over the last 2 weeks, investors see ‘safe haven’ investments and then buy bonds which has actually forced down bond yields over the last fortnight noting that rising bond yields were part of the stock market problem in the first place!
- Mounting trade tensions affecting the outlook for global growth (with Chinese stocks particularly affected).
- European stocks also affected by uncertainty about Italy. The European Commission, as expected, rejected the country’s draft 2019 budget-keeping Rome and Brussels on a collision course.
- Discouraging results from big technology groups: A cautious festive season outlook from Amazon sent it down 7.5% on Friday – its biggest one-day slump for two years. Google parent Alphabet fell 2.5% last Friday.
Emerging Markets have had their own problems falling 25% so far this year unsettled by a rising US Dollar which is continuing to benefit from the general upward trend of US rates. As the dollar rises, the cost of substantial amounts of Emerging Market debt denominated in US Dollars rises in local currency terms and becomes harder for those countries to service debt repayments. Turkey and Argentina have been particularly in the news although, in a ‘contagion’ effect, all Emerging Markets have suffered. Argentina and Turkey have both had to raise interest rates extremely sharply to support their currencies. Such moves are very unpopular with local populations and risks political instability.
Oil: Brent crude, the global benchmark, is trading at $77 per barrel just $5 short of the 4-year high reached 4 weeks ago. The fundamentals support a strong oil price at the moment with OPEC, in conjunction with major producers such as Russia, limiting supply coming to the market (a year ago Brent was $55 per barrel).A booming US economy (demand up) and President Trump’s sanctions against Iran (supply down) reducing global production by circa 1 million barrels per day are two of the causes of this year’s oil price rise.
Gold: The price of gold has generally remained subdued this year trading close to $1,200 per ounce (well below the $1,900 per ounce level shortly after the financial crisis). Attractive US equities do not help the performance of gold. It is only if inflation returns or overshoots will gold fully return to the investor limelight. However with stock markets falling over the last 2 weeks there has been a ‘flight to safety’ which has boosted the gold price to $1230 per ounce.
US Interest Rates are set by the FOMC (Federal Open Markets Committee) which meets approximately every 6 weeks. The ‘Fed’ has an unwavering commitment to ‘normalising’ interest rates. The average key ‘Fed Funds’ rate (the rate at which banks lend to each other via deposits placed at the Federal Reserve) is 5.95% looking at the last forty years. The market believes the new Fed ‘normal’ target is between 3 – 4% looking at an 18 month horizon; the level of inflation will be the key driver of this (currently US inflation is a healthy 2%).
S&P 500: 2670
FTSE 100: 7000
Bonds – 10 Year Government Yields
EUR/USD 1.1400 (1 euro buys 1.1400 dollars)
GBP/USD 1.2800 (1 pound buys 1.2800 dollars)
OIL: Brent: 77.00 (dollars per barrel)
GOLD: 1230 (dollars per ounce)
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