- The start of autumn marked a change in market dynamics. Volatility is up across the board, the US 10-year yield is flirting with its highest level over the last seven years following a rapid rise; equity markets are under pressure. After a period of highly divergent forecasts, markets are starting to price in a synchronised slowdown in global growth, and, hence, the fact that the peak in earnings acceleration is progressively shifting to being behind us. Some ongoing dislocations are accompanying this new situation. Cumulative hikes in interest rates in the US, while limited in absolute terms, have been sufficient to trigger the early stages of a risk-off positioning in emerging markets which have recently been negatively affected by idiosyncratic stories (Turkey, Argentina) with weak fundamentals. The risk-off sentiment has been further exacerbated by the Italian budget situation, while the most recent risk-off moves have also broadened their effects to the US in the tech area, which is very stretched in terms of valuations.
- Implications related to trade disputes are also a feature of this new narrative. Protectionism is a lose/lose game: no economy will be exempted from paying its bill in the end. So far, the deterioration has been more visible in a deceleration of global trade growth and in economies with limited fiscal support, primarily in the Eurozone and China. Regarding the latter, policy actions (both fiscal and monetary) are too recent to have affected GDP growth figures. The potential impact on the US has so far been hidden behind the fiscal policy boost, but we may start to see the unintended effects of protectionism as we enter the Q3 earnings season. Possible downward earnings revisions due to tariffs, coupled with some wage pressure, could be a dangerous cocktail in a late cycle phase. If protectionism becomes structural and goes beyond being an electoral trick, it could become a risk. In our view, the impact will be more on the growth outlook and should lead central banks to lean to the accommodative side.
- While this new narrative will continue to drive volatility higher, we believe that it is premature to call it a bear market. In our view, the configuration that is opening up has more to do with a correction than a full reversion to a bear market trend. Yet, we believe that the repricing in different assets will continue and it is too soon to aggressively call out any obvious buying opportunity that could emerge in areas such as Europe, once the Italian uncertainty is over, and EM, when the threat from rising interest rates and a strong dollar potentially dissipates. We have been scaling back overall risk for some time, rotating towards the more defensive spaces of quality and value on the equity side and adding duration on the bond side (core government bonds -- in particular, US Treasuries). We don’t see any compelling reason to change our view at this time, as we believe that interest rates in the US are reasonably close to peaking.
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