Jittery week comes to an end

Ed Monk
Ed Monk
Fidelity Personal Investing12 October 2018

Markets across the world have pulled back sharply over recent days, with a partial recovery offsetting some of those losses as the week comes to a close.

The S&P 500 dropped 2.1% on Thursday with bourses in Europe and Asia following suit. At one stage the US market fell through its 200-day moving average level - a technical signal of momentum in the market.

The past 24-hours has brought patches of relief with some Asian markets rallying and US shares tipped to rebound when markets open later, although some emerging markets remain on the cusp of entering bear market territory (defined as a 20% fall from their peak).

As can often happen, the nervousness appears to have been caused by better economic news. Strong US data has led bond markets to reassess their expectations for interest rates. The Federal Reserve has been tightening rates as a means to head off inflation as the American economy picks up speed. Higher Fed rates push up the yields on bonds as investors demand a higher return on bonds relative to risk-free cash.

As data has improved, the Fed has begun to signal that rate rises may have to come sooner and the market has been caught somewhat on the back foot. Hence bond yields have risen and their price, which moves inversely, has fallen.

For several reasons, that’s hurting stock markets too. It signals a rise in company borrowing costs but also reduces the attractiveness of company returns compared with lower risk assets. A key feature of equity markets recently, and part of the reason that they have ground higher despite periods of pessimism, is that investors have few attractive alternatives in other markets. Higher yields for bonds and cash changes that.

Technical measures used to value company shares are brought lower when the risk-free rate of return rises. That hurts some companies more than others, and the US tech companies that have otherwise been driving the market higher have fared the worse. Amazon, Apple and Netflix have seen huge swings in their prices this week.

In a note to his investors this week, Jeremy Podger, manager of the Fidelity Global Special Situations Fund which features on our Select 50 list, said: “The current correction is largely a spasmodic adjustment by equities to higher rates and ostensibly tighter monetary conditions in the US.

“Meanwhile the US economy is really very strong - it grew at an annualised rate of 4.2% in the second quarter.  Likewise, US corporate earnings have surprised even the most optimistic expectations from last year and this momentum is expected to have continued into the third quarter, with strategists looking for Q3 reported earnings per share in the US to be up around 25% on the same period last year.”

This, he’s added, meant that US shares remained cheaper now than a year ago. Yet he acknowledged that many of the risks facing stock markets were real, with some companies exposed to the burgeoning trade disputes between the US under President Trump and its global trading partners having made profit warnings.

“The coming earnings results season will add more colour to this picture and point to those areas where - for now at least - profit margins may have peaked”, he said.

Despite their fluctuation, markets have moved broadly sideways this year. To get a return that beats it requires active stock selection. In broad market sell-offs it can pay to invest via an active manager who is paid to sift stocks and excludes those they believe to represent undue risk.

Five year performance

(%)

As at 30 Sept

2013-2014

2014-2015

2015-2016

2016-2017

2017-2018

 S&P 500

19.6

6.4

34.6

14.8

21.3

Past performance is not a reliable indicator of future returns

Source: Thomson Reuters Datastream, as at 30.9.18, total returns with income reinvested in local currency.


Important information

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