This article is part of Morningstar's "Perspectives" series, written by third-party contributors.
Markets haven’t started the final quarter of the year the way many investors had hoped. What makes the latest volatility more troubling is that it’s been difficult to identify one specific cause. There are many symptoms but no one can diagnose the illness.
Geopolitics, rising bond US bond yields, a more hawkish looking US Federal Reserve, slowing Chinese growth, a strong US dollar and the already well-known problems in some emerging economies have all contributed to the market unease.
The focus for investors had been on corporate earnings. Against all the macro headwinds, the micro factor of strong US corporate earnings had been enough to insulate the market. So far the US earnings season has been decent, with approximately 30% of the S&P 500 companies by market capitalisation having reported and 83% of those having beaten analyst’s expectations for earnings. The anxiety in markets stems from whether this is the peak in earnings and growth, as higher input costs from rising wages, the impact of tariffs and higher funding costs start to impinge on corporate margins.
The problems in the US market are having knock-on effects on global equities, and the rising US dollar is exacerbating difficulties for emerging markets and Asia. However, the global economy is still growing and corporate earnings are still positive. They may not grow as fast or be as positive from here on out, but these are still reasons to favour risk assets and equities.
China and US Trapped by Political Rhetoric
Markets are likely to remain jittery for the rest of the year. All of the puff about the G20 meeting between Presidents Trump and Xi is only likely to result in hot air, rather than resolution of the trade dispute between the US and China. Both sides are caught in a case of political brinkmanship.
Meanwhile, central banks will continue to get top billing as the Fed pushes on with normalising interest rates and the ECB is set to end its bond purchase scheme by the year end. From there it only gets more interesting for the ECB, as it will have to decide whether it can really raise rates in the middle of 2019, if core inflation rates are still languishing at their current levels. The People’s Bank of China remains active in addressing China’s slowdown while attempting to continue to bring about financial stability, and EM central banks are each taking more aggressive stances to try and defend their local markets.
We don’t believe that this is the beginning of the end for equity markets, but rather a very timely reminder about rebalancing and asset allocation. There will likely be many events that will weight on markets for the rest of this year and into next, and it will be impossible to avoid volatility in the future. However, investors would be wise to use this market retreat to reassess and be vigilant about portfolio discipline and rebalancing.
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