The sudden break-down in headline indices is stimulating a great deal of considered comment and a tweet or three from President Trump.
The Fed’s fault? Well, in part. We summarise Governor Powell’s approach to monetary policy as “giddy up”: to temper the US economy during a period of extranormal growth and build some reserve for future cuts when the next crisis comes along. The second part has been referred to by past Governor Bernanke as “putting bullets in the gun”.
In the very short term, portfolio managers of all stripes are assessing the collateral effects of this downward move in equity markets. Questions being asked are how is the dollar responding (down a bit), how is gold responding (up a bit), how is oil responding (down US$2bbl) and finally how is the US bond market responding (down a bit in capital value terms)? Measurement of these cross correlations allows people to assess whether the correction is a crisis – the very short-term conclusion being no. The more worrying combination would be a strong move upward in gold and downward in bond yields which would be reflective of actual cash flows out of equity markets into haven assets. This has not happened in great size this week.
So, there’s a bit in this for everybody – bulls will pass it off as a typically seasonal drawdown. The month of October is a mark in every equity investors’ diary on account of past October corrections.
Fans of Big Tech will see an opportunity in Amazon at US$1,700, 17% below its year’s high.
For the more bearish, it ranks as the first engagement of an incipient bear market, a swift parry.
Looking forward, whilst we claim little predictive power on the outlook for the dollar right now, we rank runaway dollar strength as the greatest risk. Were that to continue, then the foundations of earnings momentum in the US equity market would crumble as roughly half of S&P500 constituents’ sales are out-with America. The translation effects of exchanging overseas income into a stronger dollar would be consequential and press down hard on affordability in Emerging Markets: a double-bind.
Energy prices can be decisively unhelpful at this time: higher prices creating macro volatility and adding to inflation. It would make intuitive sense to think of oil as being an economically sensitive sector. Whilst this is patently true – we also believe that the oil price is as much (and perhaps more) driven by the capital expenditure swings of its own industry: a reflex response to past energy price cycles. If so, we should understand recent strength in oil as being caused by a relative capex drought in the past few years and expect more strength to come.
Readers of our fact sheets and reports will be aware that we took a more conservative line with the core portfolio during the summer, adding cash and short dated government and commercial paper and restocking on conventional equity index put options.