The market rally since the start of 2019 has been big but fragile. This week we have seen just how vulnerable today’s high prices are to two key factors - interest rates and trade.
Shares have soared in the first four months of the year - it’s been one of the four best starts since 1970 for the MSCI World index. But because the gains have been achieved on such a narrow prospectus, the fear is that they could quite easily be handed back.
US interest rates, first. Here, the messages emerging from the Federal Reserve are mixed. Having indicated that low inflation was a challenge for the US central bank, the press conference after last week’s rate-setting meeting looked like a U-turn. Fed chair Jay Powell now seems to think that any weakness may be more ‘transitory’.
That took the market by surprise. Having started to factor in a possible cut in interest rates this year, investors have been forced to revert to their earlier expectation that the cost of borrowing might rise again. That seemed even more likely on Friday when better than expected employment data and a jobless rate of just 3.6% showed the US labour market is in fine fettle.
The Fed is struggling to communicate a clear path for interest rates. And that means the market’s reaction to events is likely to be more unpredictable and volatile.
More important than monetary policy this week has been the ongoing trade spat between the US and China. Expectations for an early resolution of trade tensions has been one of the key drivers of this year’s stock market rally. Since Sunday, however, the focus has been less on a trade deal than a trade war.
That’s because the President took to Twitter at the weekend to berate China for allegedly going back on previously agreed provisions of the deal that everyone hoped would soon be signed. Mr Trump said that unless the Chinese played ball he would increase tariffs on $200bn of imports from 10% to 25% on Friday. US officials confirmed that this was not simply a negotiating ploy - it represented real frustration with the Chinese position on intellectual property and the forced transfer of technology.
The market reaction was dramatic. Chinese shares fell by 6% on Monday before recovering slightly on Tuesday and then falling again today to a two-month low.
The falls were less extreme elsewhere, but Wall Street nonetheless was as much as 2.4% lower at one point on Tuesday. There were significant declines elsewhere too and moves into safe haven assets like government bonds and the Japanese yen.
All is not lost. China’s lead negotiator Liu He is still planning to fly to Washington this week, albeit a day later than planned and with a smaller supporting cast. It still seems likely that both sides want a deal. A full-blown trade war would be bad news for both sides and there is little appetite for that in either the US or China.
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What should investors do in the face of these rising tensions? Is this a time to capture some of the gains since the start of the year? Or will this week’s volatility soon blow over?
The short answer, of course, is that no-one knows how serious the latest row is. The stakes are high, but the odds are that self-interest will see both sides compromise in due course. A trade war benefits no-one. China is desperate to keep its growth rate up and President Trump will do all he can to avoid a recession ahead of next year’s Presidential election.
So the best approach is to stay calm and remain sensibly invested in a well-diversified portfolio. A prudent mixture of asset classes and geographies is the best way to navigate the choppy markets that follow this kind of political posturing.
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The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.