Data Source: Bloomberg
It was a clear month of ‘risk-off’ positioning as global equity markets dropped following negative headlines surrounding Federal Reserve tightening, China slowdown, and ongoing trade disputes between the U.S. and China.
The risk-off sentiment was clearly evident in sector and factor performance as investors moved towards defensive, lower volatility segments of the U.S. market. U.S. small caps also underperformed large caps and much of the rest of the world.
Credit markets also sold alongside equities while fixed income suffered from higher interest rates as the 10-Year U.S. Treasury rose as high as 3.22% before settling down into the 3.05-3.15% range.
The U.S. outperformed all other major regions while emerging markets and Asia-Pacific were the worst performers, as the latter has greater economic exposure to China versus the rest of the world.
With 3rd quarter results being reported, the S&P 500 is on track to have its best year-over-year earnings growth (projected at 20.5%) since 2011; however, estimates for 2019 have been revised downward, but earnings are still expected to grow 10%.
The Fed remains in a tight spot as it does not want to risk overshooting on interest rates for fear of pushing the economy into recession, but also wants to remain ahead of the inflationary curve, where pressures seem anecdotal at this point until they make their way into the headline releases.
China and Asia/Pac region represent the ‘beta’ trade for equity market risk-taking. If trade tensions were to thaw, then this region will likely benefit the most in a ‘risk-on’ recovery.
The prospect of more trade tariffs (and perhaps general political uncertainty) as well as tighter financial conditions brought on by higher interest rates and credit spreads seem to be driving a pull-back in appetite for future capital spending
Yet, many companies are also reporting robust end demand that has enabled them to pass on much of the higher costs associated with a tighter labor market and import tariffs; some are even able to raise prices in order to expand margins.
If investors are concerned about headlines, at least they are being better compensated for taking on ‘headline’ risk via lower equity valuations and higher interest rates.
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