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Some perspective on the market selloff
3/25/2019 6:27:01 AM
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By Fund Library News Wire  | Monday, December 17, 2018


By Kristina Hooper, Global Market Strategist, Invesco Ltd.

The past couple of weeks have seen major swoons in the stock market and U.S. Treasuries. As of this writing, the selloff has been continuing. However, I still hold out hope that we could see stocks finish higher than where they are now by year-end. Yes, Virginia, there still is the possibility of a “Santa Pause.”

Examining the causes of the selloff

Investors seem to largely be reacting to concerns about the possible escalation of trade wars between the U.S. and China. First came the realization that the Donald Trump-Xi Jinping trade talks at the G-20 meeting did not achieve the results that had initially been reported. Then, later in the week, the arrest of Huawei’s chief financial officer by Canadian authorities at the behest of the U.S. caused a significant amplification of concerns that the U.S.-China trade relationship would deteriorate. And now, with China summoning the U.S. and Canadian ambassadors over the Huawei arrest and threatening formidable action, I am not surprised to see risk assets are still down and Treasury prices are up.

In the background, there are also concerns about a global economic slowdown, which is causing a lot of nervousness and apprehension – and is clearly contributing to the fragility of the stock market. It was reported recently that Bank of Japan Governor Haruhiko Kuroda was questioning the strength of the global economy, pushing Asian stocks lower. And we have been seeing signs of a modest global slowdown – but not a recession – in various places around the world. For example, third-quarter gross domestic product (GDP) for Japan fell 0.6% quarter over quarter in the final estimate, which was below consensus and well below the preliminary reading. 1 And eurozone GDP growth for the third quarter rose just 0.2% quarter over quarter, compared with an average of 0.7% quarter over quarter last year.2

I also believe the November U.S. employment situation report has added to the downward pressure on stocks and upward pressure on Treasuries. Not only did job growth fall below expectations – striking a nerve, given sensitivity to any signs of a global slowdown – but, more importantly, wage growth remained relatively high, which could constrain the U.S. Federal Reserve’s (Fed) ability to ease up on its plans for interest-rate normalization in 2019.

Three things investors need to keep in mind

1. The relationship between the U.S. and China is likely to deteriorate, in my view – that was always my base case and should not come as a surprise. But, at least for the time being, tariff increases are on hold, and I believe that is all we could have hoped for coming out of the G-20 meeting.

2. The recent increase in U.S. wage growth is not, on its own, enough to stop the Fed from dialing down its monetary-policy normalization. In other words, I believe the Fed will not tighten as much as expected next year – and we are likely to see that in the “dot plot” released after the Federal Open Market Committee meeting. While I expect the Fed will still hike rates next week, I believe the Fed’s policy prescription for 2019 is likely to be just two rate hikes – and that should be good news for markets, in my view. (And, depending on the data, that policy prescription may get adjusted down in future dot plots.)

3. While I expect higher volatility, that doesn’t mean that long-term investors should abandon risk assets. We have long warned that volatility could increase as the Fed normalized. In addition, market turbulence has been exaggerated by program trading by computer algorithms as well as the use of derivatives – but that has nothing to do with fundamentals.

In conclusion, I was a lot more worried in August and September than I am now. Back then, valuations were stretched, and I was concerned that investors had become less confident in stocks since the February selloff, suggesting they would flee the market and turn “risk off” at the first sign of trouble. I felt that markets had overpriced the positives and were overlooking the negatives, such as the potential for the trade situation to deteriorate, at its peril. Many of my concerns have now been realized, and, in the process, much of the froth has been shaken out of the market.

While stocks could certainly move lower from here, this is not a time for investors with long time horizons to abandon risk assets, in my view. (In fact, I don’t believe there is ever a time for that, as investors need growth potential to meet their investment goals and are notoriously bad at market timing.) Rather, I see this selloff is an opportunity for investors to begin writing a “wish list” of investments they would like to add to their portfolios if they have cash available. One such area is technology; after all, some investors couldn’t stomach buying tech at levels earlier this year because of the significant runup tech stocks experienced. Now tech is much more reasonably priced, in my view. In addition, I believe emerging markets – especially Asian emerging markets – are looking more attractive given the potential for the Fed to take its foot off the accelerator next year. And, the MSCI Emerging Markets Index is actually up about 5% from its lows this fall.3

It feels like investors are walking on eggshells and have become overly sensitive to bad news. However, I do expect the next few weeks to bring some good news in the form of a kinder, gentler “dot plot” – even if we don’t get a pause in trade tensions. Hence, I hold out hope that we could at least see a modest “Santa Pause” rally by year-end. But whether or not we get a rally, I believe it’s critical that investors with longer-term time horizons and investing goals put this market turbulence in perspective – and stay the course.

1 Source: Cabinet Office, as at Dec. 10, 2018
2 Source: Eurostat, as at Dec. 7, 2018
3 Source: Bloomberg, L.P., as at Dec. 10, 2018

Kristina Hooper is Global Market Strategist at Invesco. This article first appeared in the Invesco blog.

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Important information

All stock exchange-related figures are quoted in U.S. dollars.

The risks of investing in securities of foreign issuers, including emerging-market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.

Investments focused in a particular sector, such as technology, are subject to greater risk, and are more greatly impacted by market volatility, than more diversified investments.

In a “no-deal” Brexit, the U.K. would leave the EU in March 2019 with no formal agreement outlining the terms of their relationship.

The Federal Reserve’s “dot plot” is a chart that the central bank uses to illustrate its outlook for the path of interest rates.

Gross domestic product is a broad indicator of a region’s economic activity, measuring the monetary value of all the finished goods and services produced in that region over a specified period of time.

Risk-off refers to price behaviour driven by changes in investor risk tolerance; investors tend toward lower-risk when they perceive risk as high.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The opinions referenced above are those of Kristina Hooper as at Dec. 10, 2018. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

This does not constitute a recommendation of any investment strategy or product for a particular investor. Investors should consult a financial advisor/financial consultant before making any investment decisions. Invesco does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Investors should always consult their own legal or tax professional for information concerning their individual situation. The opinions expressed are those of the author(s), are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

© 2018 by Invesco Canada Ltd. Reprinted with permission.

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