What to expect when investing in this current world of market volatility

October was a volatile month in financial markets. US bond rates rose sharply, while world equity markets swung wildly and closed down sharply on the month. As investors, it is important to understand whether these moves are significant. Why were markets so unpredictable? What can we expect going forward?

In our view, the main driver of this volatility was increasing stresses in world economies

This is driven particularly by the divergence in growth between the US (growing strongly) and the rest of the world (slowing, particularly Europe and China). Strong US growth prospects and low unemployment are giving the US Federal Reserve (Fed) good reason to continue to raise US interest rates and start to reverse quantitative easing. Other world central banks have less to cheer about and in the main are holding interest rates stable.

Rising US rates and strong economy are in turn supporting the US dollar against other currencies

This is uncomfortable for some emerging economies with high US dollar denominated borrowings. If we add to this mix a fraught geopolitical environment and equity prices that are by many measures stretched – it is not surprising that investors have been skittish and quick to see the negatives in world equity markets.

We must remember it is not normal for markets to rise in straight lines

Using the analogy of a steam boiler and a safety valve, unless the safety valve releases occasionally, a dangerous head of steam can build up with catastrophic consequences. Occasional sizeable reverses are in a sense healthy because they reduce complacency and excessive risk taking.

Actual data during October was in the main fairly encouraging

US third quarter earnings growth for S&P 500 companies that have reported to date is a stellar 27 per cent, with the outlook for 2019 a less rosy, but nonetheless healthy 10 per cent. US Gross Domestic Product (GDP) for the third quarter was 3.5 per cent, slightly beating expectations, and US unemployment was 3.7 per cent, again a decent figure.

US and rest of world economic and market value divergence is driving a stark policy divergence too

The Fed is acting to constrain the US economy – in effect working to reverse the outperformance of the US. This policy will in time likely be effective, and US growth will slow, the questions being: When? Will a recession ensue? Will that cause equity markets to fall? These are three very hard questions to answer.

The majority of commentators predict an increase in the risk of recession in late 2019 or 2020

They point to increased leverage in corporate US leading companies to be susceptible to rising interest rates as one potential factor that will lead to a sharp slowing of growth if the Fed continues along its current path. However, the fact remains that the US appears by far the healthiest developed economy, forward-looking US corporate earnings growth is still better than other world markets, and the US dollar will continue to be supported by rising US interest rates in the short-to-medium term. Holding some assets with US dollar earnings is still part of a sensible portfolio strategy, but as with all investments, not without risk. We continue to be concerned with the imbalances in world economies. Maintaining a diversified portfolio with reasonable cash balances remains, in our view, the best strategy in these times.

This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward-looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.

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Patrick Broughton

Investment Committee Chairman

With 25 years’ global investment banking experience in a broad range of financial markets, including equities, fixed income, hybrids and convertibles and foreign exchange, Patrick Broughton is charged with chairing the Dixon Advisory Investment Committee.

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