Rising pockets of market risk
27 November 2017
Anthony Rayner, manager of Miton’s multi-asset fund range, analyses recent moves in the markets which hint at forthcoming risk events
Investors are understandably suspicious of the gravity-defying characteristics of the equity market. Not only is the extended duration of the bull run unusual in an historic context but so are the apparent signs of calm, for example, very low market volatility.
However, there have been a number of challenges to this benign environment very recently. Some risk assets, for example emerging market bonds and US high yield bonds, have been exhibiting signs of stress in November, albeit after a very strong run so far this year. Also of note, the Japanese stockmarket experienced a 3.5% intraday decline, for no obvious reason.
It’s too early to call a change to the supportive environment for risk assets (e.g. economically sensitive equities, emerging market equities and bonds, and high yield corporate bonds). However, it’s worth looking at what might be behind these recent moves, as there have been a number of relatively new economic and political developments that seem to be colluding against risk assets.
The economic environment has been dominated by strong economic growth and increasing signs that global rate moves will be de-synchronised, with the US leading from the front, leaving the Bank of Japan and European Central Bank behind. We are seeing the US dollar strengthen, against its previous trend for weakening, and wage inflation building in certain sectors.
On the political level, tensions in the Middle East are ratcheting up between Saudi Arabia and Iran, while key oil producer Venezuela has just defaulted on its debt, after months of domestic political tensions. Meanwhile, progress, or lack of, on tax reform in the US seems to be driving risk appetite there.
So, what does this mean for financial markets? There are a number of asset-specific points to be made, for example continued US dollar strength will be a headwind for emerging markets. But the wider question is whether a stronger US dollar and higher US interest rates are putting increasing areas within financial markets under pressure.
This is key to understand because over recent times most risk events have been fairly contained. However, higher rates might not only increase the likelihood of risk events occurring but also, potentially, the degree to which there is contagion or not. In short, is it a head-fake, with markets simply letting off some steam after a decent run, or is it the start of something more sinister? Time will tell.
We continue to position for the primary trend, until the data set changes, rather than putting faith in forecasting market turns. As a result, we remain invested around our base case, which is to assume strong growth and low inflation, with gently rising interest rates.
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