Last week, the S&P500 plummeted as much in a single day as not since February 2018 and January 2016 before. Although the above 3% decline was clearly apparent, the drivers behind the fall were not as much. Please see a quick summary of our perspective on these market moves:
To start with, it was not the result of a single trigger, but rather the combination of multiple events that hit the markets roughly simultaneously. Firstly, the yield on the 10-year US Treasury reached 3.25% in October, the highest level since 2011. This not only means that investors now can earn measurable returns without risk – and consequently prompting investors from equities to fixed-income – but this also greatly reduces current valuations as the discount factor increases. Secondly, the impact of the long lasting trade war between US and China seems to take effect and for example the IMF has reduced its global growth projection for both 2018 and 2019. In addition, the IMF also noted in its World Economic Outlook that "downside risks to global growth have risen in the past six months and the potential for upside surprises has receded." Finally, Morgan Stanley downgraded the luxury sector as they warned that Chinese demand is waning.
What changed on Friday and why the S&P500 rebounded? Firstly, it was a relief rally that we often see after such corrections. But more importantly, we also saw a few reports published on the macro side that helped to mute these fears. For example, Chinese exports jumped nearly 15% in September compared to last year, beating analysts' forecasts and defying the impact of the US tariffs. In addition, there are talks to arrange the next meeting in November between President Trump and Xi Jinping. Finally, the US inflation (CPI) came at 2.3% versus the estimated 2.4%. If inflation is indeed not picking up, the Federal Reserve will be less forced to hike interest rates and consequently we might see yields at current levels for a longer time.
We view last week's market volatility as a result of unfortunate coincidence of these events that prompted some investors to suddenly realise some risks that were otherwise apparent for months. As for the yields, the Federal Reserve has long signalled that it is going to hike interest rates in a gradual manner – one more planned for this year – while investors are and have been pricing fewer rate hikes. Therefore, the rising yields are not surprising at all. The US-China trade tensions indeed do not seem to resolve unfortunately, although the IMF now projects 3.7% global GDP growth for 2018 and 2019, a downward revision of 0.2% compared to its last forecast in March. As such, this is still an above average growth and should support equity valuations. To summarise, we already calculated with these risks, and consequently these events do not materially change our outlook for the foreseeable future.
What could change this? Companies just started reporting their earnings for Q3, and therefore we will be closely watching how much tariffs are taking their toll on companies' profitability. Should it surprise us on the downside, we will definitely revisit our outlook.