Don’t Overreact. The Economy is Strong!

11 Oct 2018

What’s happening is that both the stock and bond markets across the globe have been volatile since 2 October 2018. In our view, there are two factors behind recent market volatility that we’ve outlined below, and there’s only one thing to do: stay in the market.

What did the markets respond to?

The Fed defied Trump, then miscommunicated its policy

It is true that President Trump has been publicly criticising the Fed since July for hiking interest rates. But the last thing the Fed should do is to let its tantrums compromise its usual clear policy communication. After the Fed completed its last FOMC meeting on 26 September, the word “accommodative” was removed from its official statement because the Fed recognises that “inflation remained tepid”. These actions were initially seen as an acknowledgement that monetary policy is no longer accommodative, and in turn led to the interpretation that the Fed could be open to slowing its pace of rate hikes. Weirdly enough, Chairman Jerome Powell then sowed confusion by immediately contradicting the Fed’s statement in saying that the “Fed could raise rates beyond the perceived neutral level of rates”. He also added that the removal of the word “accommodative” should not be misconstrued as signaling any change in policy path. The contradictions have created uncertainties for both stocks and bond markets alike. Since 2 October, the S&P 500 and 10-year US government bonds have declined by 4.7% and 0.9%, respectively.

Is the Fed acting out to defy President Trump? In Trump’s own words earlier this Wednesday, “They are so tight. I think the Fed has gone crazy”.

Many US companies are proactively managing analysts’ lofty earnings forecasts

US companies fear that analysts have been tired of under-forecasting for so long that they are increasingly raising their projections to unrealistic levels. What’s the evidence? According to Bloomberg, the number of S&P 500 companies saying that profits will trail analyst estimates outnumbers the number of S&P 500 companies saying otherwise by a an astounding ratio of 8-to-1. It’s a actually a really good thing that so many S&P 500 companies are proactively guiding analysts’ forecasts lower to more realistic levels. It makes for a healthy and sustainable investing environment. However, this brutal honesty is causing the market to overreact in the short term, which is why we are seeing asset classes, such as tech stocks, experienced the lowest 7-year drop. They'll bounce back once the analysts' egos heal.

So, what should you do? Don’t Overreact. The Economy is Strong!

Successful investing takes time and patience, and it requires staying true to your long-term investment plan. The last thing you want to do is to exit the markets just because the prices lowered; it’ll hurt you if you watch it rebound later when you have to buy back in at higher prices.

We can’t emphasise enough that it is part of the markets’ nature to go through ups and downs over time.

It is certainly not a bear market: right now, economic fundamentals are strong. Leading indicators, such as the Conference Board Leading Economic Indices, have continued to show steady positive growth rates of 6.4% YoY throughout 2018.

Even with the ongoing trade disputes on top of this, what we are seeing is market noise, not entire economic shifts. As part of our services, in the case that economic indices flagged an economic change, we would adjust all of our customers’ portfolios to withstand the new economic environment: this is not what we are seeing now.

In any case, market volatility is one of the reasons why StashAway believes it’s important for investors to own some protective assets, even when times are good. For long-term success, it is key to stay diversified. It is also advisable not to overreact to short-term events, as there is high chance of being “wrong-footed” by market price actions.

Our Recommendations

  1. Do not be hasty and overreact to sensational news headlines! Unlike fast and intense market corrections, it takes a lot longer for a bear market to develop.
  2. Stay focused on economic data. Both actual and leading indicators suggest that the economy is strong!
  3. Maintain diversified portfolios, continue to buy growth-oriented assets that are priced fairly, and buy undervalued protective assets when they show a change in momentum. If you have a dollar-cost-averaging strategy, stay true to it.

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