Synopsis of Q1 2018
- Too far too fast; In the first four weeks of the year the S&P 500 was already up by 6% and this was following 2017 where it had risen by 25%. This move saw historical valuation metrics being stretched.
- The technical correction; We wrote at the time, the catalyst for early February’s correction was inflationary data releases. This saw a spike in the volatility index triggering a number of leveraged financial instruments to aggressively sell equities.
- The battle for dominance; February and March have seen traders and investors struggling to adapt to the increased market volatility as worries over politics and trade wars have dictated sentiment rather than underlying economic fundamentals.
What should we expect from Q2 and the rest of 2018?
Volatility; An increase in volatility was evident during the first quarter and we do not expect to see this drop back to the quiet levels prevalent throughout 2017. It is worth reminding ourselves that the low volatility seen through 2017 was not the norm and current volatility levels are much closer to historical normal market conditions. After the aggressive short sharp shock in February, investors are still assessing if this was just a correction or the beginning of something more substantial. The markets reluctance to head higher is not too surprising as this is the first substantial test of investor confidence we have seen in almost two years of sustained bullish sentiment. The Fern Wealth view is that markets are still within correction territory and we will still see higher levels as 2018 progresses.
Market corrections; We believe corrections are not a bad thing; in fact, like the one we are going through now could help the longer-term continuation of this bull run. Corrections serve a number of purposes, they help to rebalance equity valuations and lower historical pricing metrics such as price/earnings multiples. From an investor psychology stance, these pullbacks or corrections offer investors the ability to increase market exposure while not feeling like they are doing so at the top of an overbought market. With many of our clients, we are working with them to create wealth through regular monthly investments into targeted investment funds. It is these ebbs and flows in equity market valuations which will help us take advantage of the cost averaging and improve the long-term returns of these investment tools.
Politics or fundamentals; All the way through the first quarter of 2018, as any regular reader of our weekly market notes will know, we have stated: “the fundamental economic outlook remains good”. It is this stability in the economic data releases we are seeing, in all the major regions, which has enabled central banks to talk about reducing stimulus measures and return interest rates to more sustainable long-term levels. In the short-term, the market is more focused on current uncertainties being created by politicians. Since taking office US President Donald Trump has run the country in the style of a company CEO rather than a politician. His slogan of “America first” is clearly a sign that he is not worried about his longer-term legacy but delivering for middle America (his shareholders). It has not gone unnoticed that President Trump’s attacks on Chinese trade tariffs have come just before the US mid-term elections were a number of important swing states are up for election.
Trade wars; The drive towards greater globalisation has become somewhat de-railed as US President Donald Trump has begun to deliver on his election promise of renegotiating American trade agreements. The President’s willingness to carry out some of this process via social media has added to the jittery nature that markets have reacted to developments. At the time of writing, China have announced their own $50 billion of increased trade tariffs on US goods imported into China in a tit for tat reaction to America’s own $60 billion trade tariff announcement on Chinese goods. As these negotiations are played out, we expect to see some aggressive market moves, especially to those sectors specifically targeted. With developments in global communication, transport and infrastructure, businesses have a much broader view of where their targeted customer lives. Many companies view themselves as international rather than national and this will be one of the biggest reasons why mutually agreeable trade agreements will ultimately be reached.
Bond markets; As equity markets have seen an increase in volatility and central banks look towards rate normalisation, we have seen yields offered on sovereign debt increasing. With the US Federal reserve bank being furthest ahead in the process of increasing interest rates, we have seen the US 10 year sovereign debt offer a yield return of up to 3%. As interest rates have been so depressed for many years following the financial crash in 2008, cash had migrated out of the bond markets into equities. This process does look like it is beginning to rebalance but we do not believe we are at a tipping point as corporate earning expectations still remain high and offer better growth potential in equities.
Swiss Franc view; Fern Wealth’s opinion on where the EUR/CHF is heading has been very clear for almost two years now and we do not feel this move is completed yet. Although the EUR/CHF has moved from 1.0785 back in June 2016 up to current levels of 1.1795 (+9.4%) we believe that the Swiss National Bank will still encourage or actively assist this move back above 1.2000 and ultimately closer to the 1.2400 level.
We will continue to monitor market developments as conditions continue to evolve and amend our investment strategy where required. For an ongoing view of how we are reading current market conditions, please keep reading our weekly notes. If you would like to discuss any of these topics in further detail or need our help and advice, please feel free to contact us.