Fram­ing the ‘what ifs’ for 2019

Yorkshire Post - Business - - VOICES - Philip Lawlor Man­ag­ing Di­rec­tor, Global Mar­kets Re­search, FTSE Rus­sell

Many read­ers will be aware that FTSE Rus­sell, part of Lon­don Stock Ex­change Group, cal­cu­lates tens of thou­sands of eq­uity and bond in­dexes, such as the FTSE 100 and FTSE 250, both in the UK and around the world. There are cur­rently over $16 tril­lion of as­sets bench­marked to FTSE Rus­sell in­dexes.

This data also gives us unique in­sight into global trends and sen­ti­ment to­wards stocks and mar­kets; from this we can draw some in­ter­est­ing thoughts as in­vestors be­gin to look to 2019.

A case in point, it is of­ten said that when Amer­ica sneezes, the rest of the world catches a cold. There­fore, is there too much com­pla­cency about the fu­ture tra­jec­tory of US in­ter­est rates?

As a tur­bu­lent 2018 draws to a close, mar­kets face a dif­fer­ent in­vest­ment land­scape than what has pre­vailed for most of the post fi­nan­cial cri­sis era. This stage in the cy­cle calls for a cleareyed as­sess­ment of the po­ten­tial risks that could up­end long-held as­sump­tions and catch mar­kets off guard.

The per­sis­tent gulf be­tween mar­ket-driven rate fore­casts and those of Fed­eral Re­serve rate set­ters sug­gests that in­vestors re­main scep­ti­cal that the cen­tral bank will stick to its pro­posed tight­en­ing path.

Such scep­ti­cism has served in­vestors well over the past decade, as sim­i­larly sud­den spikes in re­sponse to nascent signs of in­fla­tion were quickly fol­lowed by equally swift con­trac­tions as in­fla­tion­ary pres­sures abated.

How­ever, there is clearly a risk that the tight­en­ing US labour mar­ket has now reached an in­flec­tion point. US wage growth has posted se­quen­tial in­creases over the past few months and now looks to be break­ing to the up­side.

Is the mar­ket re­ly­ing too heav­ily on the per­sis­tence of a Goldilocks eco­nomic out­come? This is where growth isn’t too hot, caus­ing in­fla­tion, nor too cold, cre­at­ing a re­ces­sion.

His­tory tells us that there is a tip­ping point at which mone­tary pol­icy morphs from be­ing seen as gen­tly “tap­ping” on the brakes (still ac­com­moda­tive) to be­ing viewed as re­stric­tive, with each suc­ces­sive hike seen as “slam­ming” on the brakes. That point has typ­i­cally come when nom­i­nal in­ter­est rates ex­ceed 50 per cent of nom­i­nal GDP growth.

We can see that the spread be­tween nom­i­nal GDP and US Fed funds rates, an ex­trap­o­la­tion of which would in­di­cate that this tip­ping point is not far away.

Our pro­pri­etary, multi-met­ric Fi­nan­cial Con­di­tions In­di­ca­tors has seen the US com­pos­ite score rise to a level just be­low four over the past year. A move from three to four is deemed as tight­en­ing, while a move above four would be deemed as tight and re­garded as a po­ten­tial head­wind for eq­uity re­turns. This con­trasts starkly with the still ac­com­moda­tive scores for the Eu­ro­zone and Ja­pan.

So, are we reach­ing a tip­ping point in mar­kets? As they grap­ple with grow­ing threats posed by a stead­fast Fed rate-hik­ing regime, a slow­ing global econ­omy and a dim­ming profit pic­ture, there is a height­ened sense of risk aver­sion amongst global in­vestors as 2018 comes to a close.

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