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Important market update and opportunities

The global market sell-off explained

BY MARIAN ROSS

Sunday, October 14, 2018

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Amplified trade tensions between the US and China and increasing interest rates in the USA have been blamed for the widespread sell-off observed in developed and developing markets last week. With the exception of the Jamaican and Brazilian Stock markets, most asset prices were lower week on week.

The prices of bonds, stocks and even oil have fallen in the last week. What are some of the factors fuelling this sell-off?

Strong jobs data fuelled an initial sell-off in the bond market. Last week Wednesday, it was announced that the US Economy added 134,000 non-farm private sector jobs vs expectations of 185,000. Although this performance was below expectations, there was a large upward revision to the previous month's job numbers and combined with a hawkish Federal Reserve, this led to a sell-off in the bond market.

The yield on the 10-year US Treasury rose from 3.06 per cent on October 2nd to 3.16 per cent on October 3rd. The yield reached a high of 3.23 per cent on the 5th of October. These may seem like small moves, but they jolted and reverberated throughout the bond and equity markets.

Higher yields / interest rates affect both stocks and bonds. You may be asking, “Why are movements in the US Treasury bond yields important?”. The US Treasury is an important benchmark and it is used to price both stocks and bonds. The higher the yield on the US Treasury, the higher the discount rate that is applied to valuations of both stocks and bonds (denominated in USD).

A HIGHER discount rate leads to a LOWER future valuation for a stock or bond, hence the softening of prices for both assets.

STOCKS SPOOKED BY THE IMF?

Also contributing to the sell-off was an alarm sounded by the International Monetary Fund (IMF). The IMF reduced its estimate for global growth from 3.9 per cent to 3.7 per cent on account of global trade tensions.

The agency believes that investors have not appropriately “priced” the risk of these tensions to economic growth.

The IMF further warned of a correction in capital markets if global trade tensions and geopolitical risks escalate. Germany also reduced its 2018 GDP growth forecast to 1.8 per cent from 2.3 per cent as a result of “protectionist policies and international trade conflicts”.

This rhetoric refocused the spotlight on the trade war between the US and China and was largely blamed for the sell-off in the stock markets.

ITALY'S CONTROVERSIAL SPENDING PLAN DRAGGING EUROPE LOWER

Italy's populist Government has approved a spending plan that might put its budget deficit as a per cent of GDP in breach of EU fiscal rules.

According to the Italian finance minister, the funds are to finance a new income support programme, a lower retirement age and corporate tax cuts. This fuelled a sell-off in the country's debt as well as a broad sell-off in European stocks and bonds.

The country is highly indebted, and banks are laden with bad loans that are difficult to dispose of (due to unfavourable legislation). This was interpreted as a bearish signal for European growth.

BRAZIL AND JAMAICA

Brazil and Jamaica both made headlines with more positive news.

On October 3rd, Bloomberg News published an article highlighting Jamaica's stock market performance; 233 per cent over the past 5 years. The steep rally has been fuelled by high levels of JMD liquidity and ultra-low interest rates. To the extent that monetary policy remains accommodative and economic growth picks up, the local stock market could continue to deliver value to shareholders.

In Brazil, reduced political risk was cited as the reason for the rally in Brazilian stocks and the Brazilian currency. The success of the far-right Presidential Candidate Bolsonaro (a controversial former army captain) in the first round of Brazilian elections has been interpreted positively by the market. The second (and final) round of elections is scheduled for October 28 and the market seems to have priced in a Bolsonaro victory.

WHERE CAN WE LOOK FOR OPPORTUNITIES?

Long-term investors generally avoid trying to time the market. They try to capture attractive value in any environment. At this stage, we see value in short-dated European fixed income securities with minimal Italy exposure. The US stock market still looks rich but there are pockets of value that require careful due diligence.

Marian Ross is an assistant vice-president of Trading & Investment at Sterling Asset Management. Sterling provides financial advice and instruments in US dollars and other hard currencies to the corporate, individual and institutional investor. Visit our website at www.sterling.com.jm . Feedback: If you wish to have Sterling address your investment questions in upcoming articles, e-mail us at: info@sterlingasset.net.jm.

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