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LGT Beacon: Big selloffs and midterm elections bode well for a rebound

November 16, 2018

Fear of further increases in US interest rates and some other looming anxieties culminated in a major equity selloff early this month. However, the broader markets' signals were more constructive: yield curves steepened, breakeven rates ticked up, credit spreads narrowed, and emerging markets assets stabilized; so we decided to buy the dip in equities.

Stock prices have started to stabilize this month, after the biggest selloff in years in October. For US equities, it was the worst since 2010. The most convincing trigger for this phase were policy signals by the US Federal Reserve (Fed).

Make Fed policy restrictive again

After all, the selloff began on Oct. 3, when Fed Chairman Jerome Powell in unscripted comments remarked that monetary policy was still supportive of growth, probably "a long way from neutral," and that it might eventually have to turn "restrictive." This potential shift was confirmed on Oct. 18, when the Fed published its last meeting's minutes, revealing that policy makers had discussed making policy restrictive by the end of 2020.

Of course, such considerations are not really new and conditional on how the economy continues to perform. Importantly, they are the appropriate consequence of a stronger and hence potentially more inflationary economy. Nevertheless, these developments scared or influenced many investors, particularly those with short-time horizon strategies, no firm fundamental convictions and/or low risk tolerance levels.

In addition, these concerns come at time when elevated political uncertainties (trade war, Brexit, Italy, etc.) frequently weigh on sentiment, and after the cyclical upswing of 2016 and 2017 has faded in most of the world. Investors now fear that the positive US economic momentum and hence earnings growth has peaked as well.

Against this background, today we highlight the fundamental backdrop of our relatively constructive assessment for risk assets and examine some potentially relevant historical market behavior patterns and current market signals. These observations help to underpin our forward-looking assessment for risk asset markets.

Cyclical slowdown may be ending

First, on the macro picture. The manufacturing purchasing managers’ indices (PMI) published in November show that that slowdown may be ending in most major economies: the PMI for the US, Japan, and the emerging markets (EM) are pointing higher (graph 1), with the national readings for its top-five economies, i.e. China, India, Brazil, Russia, and South Korea, all up as well.

Only Europe continues to decelerate, as it has during all of this year (after an impressive surge in 2016-2017). However, all PMIs remain above the growth threshold. Hence, while economic growth will be slower in the coming year, a further meaningful deceleration from current indicated levels looks increasingly less likely.  

Specifically, we assess these five topics as follows: read on in the attachment by downloading the LGT Beacon

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Note: The next edition of the LGT Beacon is scheduled for mid December 2018.