We hope you enjoy the final Market update for 2018 and from the team at SALA Financial Services we wish you a very Merry Christmas
Summary
Over the past two months, global equity markets have traded with a higher degree of volatility. In the US, equities are down around 10% on September highs. The overall tone remains fragile with markets lacking conviction. Markets seem to be torn between viewing the recent bout of volatility as a good thing and improving valuations and re-basing, or a signal that earnings growth will underwhelm in 2019. There is some risk that equities trade lower and for credit markets, spreads could trade wider. Closer to home, the ASX200 is also down around 10% from the highs of late August 2018.
There has also been growing divergence between the bond market and the credit market. Bond markets have barely moved (yields are down slightly), while credit spreads have been widening. This has highlighted increased market uncertainty in the midst of issues including Brexit, Italy budget issues, and increasing trade tensions between the US and China. Brexit concerns and Goldman’s 1MDB scandal have driven bank credit spreads significantly wider, while corporates also struggled as market concern around profitability/debt burdens in the BBB space increase (high yield space) and the U.S. tech correction deepens.
Since the beginning of October there have been two attempted recoveries in stocks (S&P 500). The first saw a +3.0% bounce, the second was +6.4%. In both instances a new low was subsequently set. If this trend is to continue, there is a further downside for US stocks to test new lows. Similarly in credit, spreads are testing new wides. Markets are very much in discovery mode, with conviction in either direction weak.
WHAT COULD RESURRECT CALMER MARKETS?
In the broadest possible terms, resolution of the US vs China trade spat, which is considered low probability and although Trump has been trying to put a positive spin on upcoming talks with China. A more dovish Fed would likely ease market concerns. In this regard we point out that Fed funds futures currently imply just 50bps of rate hikes by December 2019, compared to 75bps a week ago.
There are a number of key known risks in markets at the moment that on any given day create negative market sentiment. Below, we provide an update on key issues impacting financial markets.
US ECONOMIC OUTLOOK AND US FEDERAL RESERVE OUTLOOK
Economic growth has been strong because of tax cuts. But higher interest rates and fading fiscal stimulus will slow the economy. Leading indicators suggest economic growth will slow in the next few years, but no recession.
The debate on the possibility of a Fed rate hike pause has heated up recently following Fed Chairman Powell’s comments a few days ago. Media has reported this week that the Fed could pause rate hikes to early 2019. The market pricing of Fed Funds rate hikes has been reduced recently to just over 50bps by December 2019 from about 75bps a week ago (i.e. reduced to just two more rate hikes, down from three). The CBA house view remains for one rate hike in December 2018 and two more in H1 2019.
GLOBAL GROWTH OUTLOOK
Following the IMF’s downgrade of global growth, the OECD revised down their global growth projections for 2019 and 2020 to 3.5% from 3.7% previously citing deteriorating prospects in some emerging markets and tighter financial conditions in advanced economies. Furthermore, the OECD also warned that “increased trade tensions and uncertainty about trade policies remain a significant source of downside risk to global investment, jobs and living standards”.