Global markets have continued to fall in recent days and further volatility looks likely. But what are the causes of recent reversals, and should they prompt a fundamental reappraisal of market prospects?
1. Recent market falls have been encouraged by multiple concerns, e.g. around U.S. yields, China and Italy.
Current market concerns include the recent rise in U.S. yields, problems in the Chinese economy and markets (in part due to U.S./China trade tensions), and Italian budget proposals. Markets also remain worried about the outlook for oil prices and may become concerned that U.S. Q3 earnings could disappoint compared to existing very high expectations.
2. These concerns will eventually be resolvable, but expect continued volatility for several more months.
We believe that these concerns will eventually be resolvable. U.S. yields have been driven up by strong U.S. growth, increased Treasury supply, Fed policy normalization and inflation worries. However, we do not think that a further sustained rise in U.S. yields is likely as we believe that U.S. inflation is unlikely to move much higher. Higher yields will make Treasuries more attractive to foreign investors (putting downward pressure on yields), the impact of a threatened sustained rise in U.S. yields would also tend to autocorrect. As regards China concerns, we think that policy measures and better news on the U.S./China trade dispute should improve Chinese market sentiment towards the end of the year. On Italy, we believe that the Italian government will prove reactive to market pressure and that a full-scale dispute with the EU will be avoided. As regards U.S. earnings, we stay positive for also reasons we discuss on page 2. Concerns around oil prices could come into sharper focus as the deadline for U.S./Iran sanctions approaches, but we continue to believe that production from other sources can offset any fall in oil availability: our 12-month forecast here is USD65/b.
3. Global growth will underpin risky assets, but guard portfolios against such continued volatility.
It is worth putting recent market falls into an historical perspective. As we discuss on page 2, falls of 5% on the S&P 500 are not that rare – in fact we get an average of a little over three such falls each year. It is also worth remembering that the global economy is likely to continue to grow – if at slightly slower pace than we expected a year ago – and this should help underpin risky assets. So we do not believe that this is the time to make major change to broad asset allocations within portfolios but we do think that it is sensible to try and guard portfolios against the possible consequences of several more months of volatility. Such measures, in addition to diversification and risk control, could include sub-asset class (e.g. sectoral) changes to boost portfolio quality and thus resilience.
To download a PDF of the full report, please click here.