Summary

• Global equity markets fall in a heap as continuing monetary policy normalisation begins to weigh on sentiment.
• Technology sector was hit the hardest as investors took profits on those sectors which had run the most. Vulnerable segments like emerging markets were also hit more than developed markets.
• Markets worried about how late in the cycle this US economic expansion is, and hence, despite economic strength, these bouts of volatility are likely to continue.
• US 10 year Treasuries hit highest levels in seven years as economic strength underlines continued upside inflation risks and likely further US Federal Reserve (The Fed) rate hikes.
• After markets dropped we made decision to add to equity positions from our previous underweight, favouring increased exposure in US, where the earnings outlook remains better than most other regions.

Market update

The equity bull market finally capitulated in October as the reality of late stage US economic expansion combined with the reality of rising interest rates hit home. The relative economic strength of the US against most other major regions meant that the US dollar was also seen as the safe haven currency in the turmoil, which exacerbated currency weakness in all other currency crosses.  

The reality of tightening monetary policy combined with the uncertainty of the trade policy will most likely continue to weigh upon market risk tolerance. Thus, despite the positive economic outlook, we are likely to see a bull market behave more like a sheep at times, with positive returns interspersed with bouts of anxiety and volatility.

The prospect of positive returns going forward will require earnings growth momentum and corporate profitability to be sustained. These will be key to whether we see further falls in equity indices or whether risk appetite returns and stabilises market sentiment. At the moment however, markets are struggling to interpret the positive macro data combined with leading indicators pointing to a slowdown. Is now the correct time to flee for safety or is that a premature strategy? The slowdown in China also exacerbates this, as at this stage it is unclear as to how much fiscal stimulus China can afford, and at the same time, the US trade war rhetoric does not help. A weaker currency is but one option, but induces worries about rising domestic inflation and then requiring monetary tightening. So for the time being, given these uncertainties, we deem it unwise to position for tail-risk scenarios either way – good or bad, as at the moment macro outcomes are clearly binary and mutually exclusive in nature.

In emerging markets, some of the countries perceived to be most vulnerable have staged significant recoveries, in particular in the FX space. Turkey, for example, has shown a remarkable recovery in the value of their currency, appreciating almost 15% in the two months to end-October, and the Brazilian real likewise strengthened over 10%.  By way of comparison though, the South African rand lost almost 1% over the same period, although this may be more because of South African idiosyncratic risks.

With that in the backdrop, the MSCI All Countries Index fell 7.6% in the month while in the fixed income space, the FTSE World Govt Bond Index continued falling, losing another 1.1%, bringing cumulative losses in the past six months to over 4%. In short, the only safe place to have hidden would have been in cash.

Portfolio strategy

We continued to shift our regional risk positions, whilst making use of equity market weakness to upweight our equity positioning closer to neutral from previous underweight. We also initiated a small option-based position in UK equities from a previous zero position. This gives us exposure to a positive Brexit outcome but limits the downside should a negative Brexit outcome be forthcoming.

Asset allocation strategy as at 31 October 2018

Disclaimer

Not all products described in this document are available in all jurisdictions and some are available on a limited basis only due to local regulatory and legal requirements. The material contained herein is not intended for use by persons located in or resident in jurisdictions which restrict its distribution. Persons accessing this document are required to inform themselves about and observe any relevant restrictions.