Woulda, coulda, shoulda’
John Bilton, global head of Multi Asset Strategy at JP Morgan Asset Management, reviews October markets’ landscape and shares his views for the end of 2015.
October’s relief rally (the best returns in equities in four years) should have provided just that – relief. The trouble is that with positions washed out, sentiment still fragile and macro data still mixed, few participated fully in the move and many simply didn’t believe in it.
We are not surprised by the lingering deficit in risk appetite, and agree that a degree of caution remains warranted. After all, the third quarter was the worst three month stretch for the S&P 500 since the third quarter of 2011.
Many commentators—bullish and bearish alike—appear very happy to call for a correction when they feel one is overdue but nobody likes them when they finally turn up, and sentiment tends to take a lot longer than prices to repair.
So what comes next? A continuation of the sharp rally in risky assets or a rapid deterioration into recession is equally implausible, in our view. Our best guess is an unconvincing grind modestly higher into year-end, with stocks and bond yields slightly higher, commodities still weak and credit providing the best of the returns.
To put October’s market moves into context, the S&P 500 rose 8.3%, its best month since October 2011, US high yield spreads contracted 67bps and investment grade by 10bps, the most since February, and emerging market (EM) equity rallied 6.8%%, its strongest month since January 2012. By contrast, yields on the 10-year US Treasury rose 11bps over the month—but only in the last two days of October, after the Federal Reserve (Fed) reiterated that December is a “live” meeting.
The negative correlation between stocks and bonds seems to be reasserting itself to a degree, but with the start of rate hikes still in play for December, many investors will continue to question how attractive bonds are as a portfolio hedge to stocks. The upshot is a continuation of the tempered risk appetite we’ve seen since the summer.
Even if October has some subtext of “woulda, coulda, shoulda” for the many battered investors who merely watched the rebound from the sidelines, the relative calm has given welcome pause for reflection. We think there are four major factors that multi-asset investors are now weighing:
1. Risk of recession in developed markets, which we maintain is still very low;
2. Liquidity, boosted meaningfully by the dovish remarks from Mario Draghi of the European Central Bank (ECB) and the rate cuts from China;
3. EM stabilisation, helping to stabilise sentiment more broadly;
4. Policy, will the Fed move in December, and, does it matter?
Of these four factors we focus on the first; it is the most important call that any investor—multi-asset or otherwise—will make. For further simplification, it is specifically the risk of a U.S. recession that is most important to calibrate.
The tightening of global financial conditions may have helped to trigger the correction over the summer, but aggregate financial conditions indices remain well shy of recession levels. Emerging markets can, and probably will, continue to face slowing growth but they are unlikely to tip the world into recession – even if they continue to restrain the global manufacturing sector.
Policy rates will adapt to prevailing economic conditions and US third quarter real GDP at 1.5% was neither a surprise nor a comfortable backdrop against which to see rates higher. Focus must now shift to the US jobs report on 6 November for further clues as to whether the Fed will move in December. So what of recession risk?