In Scope:

Spring is here, Volatility is back!

February 6, 2018

 

Markets react sharply: time to panic?

 

A stock market correction ...So, what is going on?

To state the blindingly obvious: 'stock market corrections happen all the time!' Nonetheless, each one does make us jump a little. And it's no different this time, either. But more than that, after a virtually soporific 2017, where not a word was uttered of stock market corrections and the rate of fluctuations sank to an all-time low, some investors now seem to have been most rudely awakened.
 

Is Goldilocks about to pack her bags?

That 2017 was an investor's year in which we remained plain-sailing in calm, untroubled waters had everything to do with 'Goldilocks'. A dream scenario for every equity investor:
  • strong, burgeoning economic growth;
  • no inflationary tensions;
  • meaning the central banks continue with their stimulative low-interest-rate policies.
But every fairy tale must end sometime. That strong, burgeoning economic growth translates sooner or later into higher inflation figures, upon which the central banks tighten their policy. Increasingly investors seem of the view that the American fairy tale is now over. The latest US labour market report was beyond compare! Yes, you needn't rub your eyes: it's an excellent labour market report that underlies this stock market correction. Things used to be different. Last Friday, it was not just revealed that a further 200 000 jobs had been created. The surprise came with the wage rise of 2.9%.That a scarce labour market leads to a rise in wages is a well-established economic pattern but many people viewed it with astonishment as a first indication of mounting inflation. All of a sudden, the financial markets fear that the US central bank (the Federal Reserve) is set to speed up raising its key rate. The consequence: interest rates up; so, bond prices and equity markets down!
 

But no such course needs to be steered at all

The graph shows that economic growth and interest rate levels go hand in hand! The unbridled global creation of money by central banks depressed interest rates to exceptionally low levels.
Now they're starting to bring their policies back into line, it should come as no surprise that interest Rates are returning to normal levels, i.e. rising. Moreover, we're still far below the interest rate levels at which economic growth starts to suffer.
 
Goldilocks ain't goin' nowhere just yet. In countries where the jobs market shows signs of supply shortages, like the US and Germany, we anticipate wage rises. But this progress in labour markets isn’t present elsewhere yet. The jobs market can therefore pick up across the entire euro area, there's no shortage of labour to fill vacancies. The 2% inflation target figure advanced by the European Central Bank is therefore still very distant. Frankfurt is also considering its next step in monetary policy terms but its first interest rate rise doesn't seem to be in the offing until well into 2019.

Graph: US economic growth and bond rates from 1951 to 2015
 

Investment implications

To our mind, there are no immediate grounds to shift our stance:
  • We cannot deny that the markets are pricing equities handsomely. This makes them vulnerable to stock market corrections, as is now being demonstrated.

  • But a strong global economy and sturdy growth in corporate earnings should provide sufficient support. The latest economic data and corporate results continue to paint a hopeful picture.

  • Ebullient business confidence gives us reason to be optimistic over the coming few months. Interim corporate earnings reports in the US seem to be very good, with turnover growth of well above 9% and profit growth of nearly 15%, which is more than 3% better than forecast.

  • The fact that many government bonds have become a 'non-yield risk' has frequently been alluded to in the past. Considerable underweighting and limiting the interest rate risk remain the watchwords!

  • Cash in euros constitutes the only truly risk-free parking opportunity. A slight rise in volatility means the chance of new opportunities is on the up.
 
(*) The investment strategy described in this document relates to all investment funds (undertakings for collective investment) managed by KBC Asset Management NV, which make explicit reference in their investment policy, as laid out in the prospectus, to KBC Asset Management’s investment strategy. The stated strategy is not, therefore, altered in the case of other investment funds, the investment policy of which does not refer directly to KBC Asset Management’s investment strategy. It is possible that these investment funds are managed in a way that differs from the investment strategy. You should always read the prospectus and the Key Investor Information Document for the relevant investment fund.
 
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