With analysts predicting more aftershocks, investors must decide whether to stand their ground or run for cover?
The global stock market meltdown that began in late January hardly came as a surprise, analysts have been predicting it since the last major crash two years ago.
February turned out to be the market’s worst month in two years, with an estimated $5 trillion wiped off global share values at one point.
The US market suffered an official correction after falling more than 10 per cent from its record level in January but panic faded as buyers decided this was not the end of the world after all and charged in to take advantage of reduced share prices.
The benchmark US S&P 500 ended February 3.9 per cent lower – its first monthly decline since March last year – while the FTSE All World Index recorded its first monthly drop since October 2016.
Further aftershocks are to be expected, they always are, and investors remain on edge. They look at the bond yield curve, which predicts rising interest rates, and tremble. They glimpse the global debt mountain, and shudder.
Finally, they look at US President Donald Trump, whose proposed trade tariffs wiped another $600 billion off share values late last week, and cover their eyes.
Some anxiety is to be expected at the end of a bull market run that began exactly nine years ago this month, at the darkest point of the financial crisis in March 2009. This is now the second longest bull run in history and plain common sense suggests it cannot go on forever.
More aftershocks seem likely as volatility whips up once more following the dead calm of 2017, so should investors duck and cover or stand their ground?
Bull markets do not die of old age, the old saying goes, but are killed by the US Federal Reserve hiking key interest rates. That is exactly what investors fear is going to happen now.
The big worry is that the Fed, now led by new chair and Trump appointee Jerome Powell, will accelerate the pace of rate hikes in a bid to cool inflation and prevent the economy from overheating.
Lee Wild, head of equity strategy at stocks and shares website Interactive Investor, says Mr Powell has made a hawkish start. “Latest US jobs and employment data only increases the odds of a more aggressive rate tightening cycle.”
Low interest rates saved the global economy nine years ago, but also encouraged a global borrowing spree, with debt soaring to a mind-boggling $233tn in the third quarter of 2017, according to latest figures from the Institute of International Finance, a rise of 8 per cent over just nine months.
Higher borrowing costs will hurt heavily indebted businesses and individuals everywhere in the world. If you have a large mortgage in the UAE or overseas, that may include you.
Nobody doubts higher rates are coming, the only question is how quickly. Currently, the Fed is pencilling in three more hikes this year. Investors might want to scream if it goes faster than that.
Anticipation of rapid US rate hikes will also drive up the US dollar which would hurt emerging markets, whose spiralling debts are denominated in dollars and will become more expensive to service.
The dollar effect
Dollar strength will also hurt the United States, hitting exports and company earnings when overseas profits are repatriated.
Yet in many respects, inflation is good news. Andrew Swan, head of Asian and emerging market equities at fund manager BlackRock, says it reflects a synchronised global recovery, with China and Asia leading the charge.
Asia is in a good place right now and can withstand a gradual increase in the dollar and US government bond yields, Mr Swan says, provided rate hikes are not too aggressive.
“It remains one of the fastest growing regions in the world, valuations are still reasonable and short-term volatility can offer attractive opportunities to long-term investors,” he says.
China has grown strongly over the last two years with companies reporting strong profit growth, Mr Swan adds. “Its growth is spreading across Asia and we are starting to see green shoots in countries such as Indonesia and India.”
He says the recovery in 2018 will be much broader and deeper, and we will see other markets catch up with China.
So bullish voices still exist, even if the bears are getting louder. Fawad Razaqzada, technical analyst at Forex.com, says the US stock market is now vulnerable to a further correction. “Not only are US equities severely overvalued in whatever metric you use, the prospects of higher interest rates means we may be near the top of the cycle, if we haven’t seen it already.”
When long-term trends turn “large pullbacks” typically follow, and February’s recovery may be a temporary reprieve, Mr Razaqzada adds.
Brexit is another concern, as the UK reels from political division, tough European Union negotiating tactics and the “Beast from East”. Meanwhile Europe has problems of its own with the populist surge in Sunday’s Italian election and once mighty German Chancellor Angela Merkel only securing her fourth term after fraught coalition negotiations.
Chris Hiorns, fund manager of Amity European Fund at EdenTree Investment Management, says Germany is his biggest concern. “An unstable government has the potential to undermine the progress of the European project.”
The prospect of a global trade war engulfing the US, China, EU and just about everybody else – could this be the black swan event investors have been anticipating for years?
Mr Trump may cheerfully tweet that “trade wars are good, and easy to win”, but history tells a different story. The protectionist Smoot-Hawley Tariff Act in 1930 is blamed for worsening the Great Depression and fuelling the rise of fascism, but Mr Trump appears to have forgotten the lesson, if he ever knew it.
The US introduced steel tariffs as recently as 2002, but they were quickly withdrawn after hitting US competitiveness and destroying around 200,000 domestic jobs.
Peterson Institute president Adam Posen has called Mr Trump’s proposed 25 per cent tariff on steel imports and 10 per cent aluminium, designed to safeguard American jobs in the face of cheaper foreign products, as “straight up stupid”.
US trade partners and allies are already preparing to retaliate, with the EU drawing up targeted tariffs on Harley Davidson motorcycles and Florida oranges.
Friday ended with another bout of selling and Chris Beauchamp, chief market analyst at IG, which has offices in Dubai, said: “Markets were swimming in a sea of red with gold being furiously bought as risk assets were dumped unceremoniously overboard.”
Investors remain in a fragile state of mind, “alternating between rampant optimism and unbridled pessimism”, Mr Beauchamp adds.
We will soon discover whether Trump is all bluster, or really means to destroy business. Hold onto your hats.
A volatile future
If 2017 was the year that stock-market volatility died, 2018 has seen it return with a vengeance.
Ashley Owen, head of investment strategies at AES Investments in Dubai, says it is impossible to say whether these are temporary storms or something more enduring. “Nobody knows, nobody has a crystal ball, and anyone trying to call it is likely to get it wrong. Speculation is fun, but you should never take it seriously, there are too many variables.”
One thing can be said with greater certainty. As monetary policy normalises and interest rates rise, the era of low volatility is over, Mr Owen adds.
Steven Downey, chartered financial analyst candidate at Holborn Assets in Dubai, says volatility can have an upside as well as a downside. “If you are investing for the long-term, this gives you an opportunity to invest on the dips, and pick up your favourite funds or stocks at reduced prices.”
Every investor dreams of buying low and selling high. Stock market volatility is your chance.
Peter Garnry, head of equity strategy at Saxo Bank, says while fears over higher inflation and interest rate triggered the recent stock dump, another factor was at play. “The sell-off was exacerbated by funds covering short positions. It turned out this was a very overcrowded strategy that led to sharp technical correction in equities.”
He believes the strong global economy can overpower the bears this year, amid strong company earnings and management outlooks. “However, we are entering the late stage in the economic cycle, which is likely to push earnings and stock prices higher before the economy enters a recession.”
The danger rises every time the Fed hikes rates, Mr Garnry adds. “A bear market and recession will eventually come, but that is likely not a scenario until well into 2019.”
If Mr Garnry is right, investors should enjoy 2018 while they can. They should also put recent turbulence in perspective. The FTSE All World may have fallen in February but is still 19.4 per cent higher than one year ago, and is up 66.5 per cent over five years. Long-term investors are still sitting on handsome gains.
Savers who prefer to leave their money in cash on near-zero interest rates may think they are playing safe but they have only witnessed its value erode in real terms.
A balanced portfolio of shares, bonds, cash, commodities and property is the best way to protect yourself. If the market corrects again resist the temptation to sell. And if you have a bit of money to spare, take advantage of this buying opportunity.