David Baker, Partner and CIO, analyses the apparent evaporation of confidence in global stocks and questions whether it signals the end for the “Easy Money” era:
"After a strong start of the year for equity markets, global stocks shed almost 5% of their value on Friday and Monday. US equities are now 6.2% below their highs, turning negative for the year, as are global equities (-6.5% from their highs). The S&P 500 is now trading at 17.16x its earnings, significantly below the nearly 20x levels it was trading at seven weeks ago. These falls should of course be considered in the context of the very strong equity markets we have seen over the last few years; global equities rose over 19% in local currency terms during 2017, and had added a further 3.8% in January alone.
"Why then after such strong returns has confidence seemingly evaporated? Although we have seen some softening of economic data in recent weeks, the global economic backdrop remains strong with most indicators suggesting stronger growth during 2018. The problem then is not a lack of growth, but a fear that strong growth and tight labour markets will translate into inflation and force central bankers to raise interest rates more quickly than the market expects.
"The sell-off accelerated significantly on Friday afternoon, when data revealed that wage growth in the US was much higher than previously anticipated. Wage growth is considered the most significant component of long term inflation. Up until that time, markets were pricing in 2 interest rate hikes for 2018. However, after the data, traders realised that the Fed, not headed by Janet Yellen any more, could pursue a more aggressive approach, hiking 3 or even 4 times this year. As a result, US yields spiked at 2.84% in early Monday trading significantly higher than the 2.40% levels at the beginning of the year.
"The possibility of a correction brought about by high bond yields has been our key risk factor when considering the asset allocation of our clients’ portfolios. Indeed we wrote in our January update that “Globally, the greatest mid-term risk is the potential of an upside surprise to growth compelling central banks into tightening monetary conditions faster than expected. We also feel that markets are pricing conditions to perfection which could lead to some disappointment. We are also getting closer to calling the end of the “Easy Money” era.”
"For us, the crucial point is how the new Fed Chair might react. Normally, a simple statement from the Fed Chair indicating that accommodative policies will be a priority of the new leadership of the world’s de facto central bank would calm markets. However, as Mr. Powell is very new to the job (being inaugurated on February 5th), we wouldn’t be too surprised if it took a little time for that statement to come".