Fed rebalancing rocks markets
Global markets are bleeding, with $8-trillion wiped off the value of equities in October alone.
Observers claim that, at best, the sell-off is a major correction or, at worst, the beginning of a collapse.
Indicators are that consumer confidence in the United States was at a 18-year high this week, the US continues to show better-than-expected economic growth, unemployment is at just 3.7% and inflation is close to the 2% target. Other markets such as Europe, China and emerging markets are showing slower growth.
Volatility in the equity market, as measured by the Vix, has been rising gradually, to more than 20% in October, since spiking in February.
The hottest stocks in recent years, the FAANGs (Facebook, Apple, Amazon, Netflix and Google), have also shown declines.
Market Watch reports that, in the past month, Amazon fell by 16%, Facebook dipped by 4.4% and Netflix was down 17%.
The tech-heavy Nasdaq last week registered its worst single performance since 2011, sliding 10.59%.
In the broader market, the S&P 500 last week lost gains it made this year. On Tuesday, it closed 1.57% higher, but still has a way to go to make up for the 7.65% loss in October.
The Chinese Shanghai Composite and Hong Kong’s Hang Seng are in bear-market territory, both falling by more than 20% this year. Chinese economic growth has slowed this year because of domestic factors and a slowdown attributed to tariffs imposed on Chinese goods by the US.
Emerging markets generally were not spared the pain. The MSCI’s emerging market benchmark index fell by 9.2% in October. In South Africa, the JSE Alsi index was down by just under 10% in October, in part because of the large exposure to Chinese giant Tencent through local tech giant Naspers, which was down by 25% in October.
Naspers saw signs of recovery on Wednesday, closing 9.4% higher, in part because of an MSCI decision not to exclude or reduce the weighting of equities with unequal voting structures in its benchmark indices.
Two main factors are behind the global sell-off: the increase in the Federal Reserve’s funds rate, which has had rises in the 2% to 2.5% range, and, to a lesser extent, trade uncertainties resulting from US President Donald Trump’s tariff wars.
The Fed has made it clear that more increases can be expected as it attempts to realign the rates with the strength of the economy.
Investment strategist Izak Odendaal said concerns about the central bank adopting a more hawkish position on rates were twofold.
The first was because investors, who had poured money into equities to get better returns, were now moving their money into bonds as interest rates rise; in the case of US treasuries, from zero to just over 3%. Second were fears that the Fed might increase rates too rapidly or by too much, leading to a recession.
“That has been the track record of the Fed that, whenever it tried to cool off the economy, it has always resulted in an outright recession,” Odendaal said.
Because shifts in US markets influence the movements of global markets, it was not surprising that recent outflows had echoed globally.
Kevin Lings, Stanlib’s chief economist, said financial markets were recognising that significant global liquidity was starting to be reversed, primarily by the US, and the trend was likely to continue. As a consequence, investors were beginning to pay more attention to the risk parameters associated with different assets and countries. “All of these adjustments are trying to find a new normal for this environment after eight years of abundant liquidity,” Lings said. “It’s entirely possible that, every time you change to market conditions, there’s a risk that this becomes disorderly or a rapid adjustment, which would be a market correction or crash.
“To say there would be a severe market correction, that’s not something that I would be able to forecast or conclude because markets correct all the time.” A note by Oxford Economics said the markets were in a “precarious loop” and, should financial conditions deteriorate further and there were significant liquidity drains from global equities, there would be a 20% likelihood of a global recession.
On the question whether global markets were heading for a replay of 2008, Odendaal said it was a once-in-a-100-year event. “I think the aftereffect of the crisis on the psyche of the investor has really played a role. There’s a consistent nagging worry that this is not going to last,” he said, adding that this had been termed the “most unloved bull market ever”.
Lings said a disorderly adjustment was more pronounced for emerging market countries that were
vulnerable because they had not managed their macro factors properly. These included high increases in debt and growing budget deficits and current account deficits, which make countries reliant on foreign investment, all of which have become a concern for South Africa.
He said the chief factor providing South Africa with a safety net was its limited exposure to foreign currency debt, which minimised the damage of a weakening currency. But the country urgently needed to increase its economic growth rate and improve liquidity.
Investors seeking safe ground as the volatility and uncertainty unfolded were shifting their money out of equities into US bonds, Lings said.
There was also evidence of people sitting on cash, waiting to see what the rebalancing could mean. Investors were seeking quality investments that might have been ignored but showed signs of good growth and returns.
“The US bond market is seen as the safest in the world, rightly or wrongly, and yet US government debt is the highest it has ever been. It’s not as if the US can brag about their economic fundamentals when it comes to government finances. But the dollar remains the reserve currency of the world,” Lings said.
Tebogo Tshwane is an Adamela Trust business reporter at the M&G