Global equity markets are roughly unchanged over the past two weeks; but that masks a lot of volatility, given that they fell 6% in the past four days and remain down about 10% QTD.

 

As recent losses continue to mount in most asset classes, it is informative to review what exactly has changed in the past 60 days. Recall that the initial catalyst came in early October: a statement by the Fed Chair that interest rates “remain very accommodative” implied further rate increases. As both the month and Q3 earnings reports progressed, market concerns evolved, contemplating the risk that the Fed’s measures to slow growth might compound with rising inflation to meaningfully hurt corporate margins in 2019.

 

A series of negative US-China trade headlines both before and after the mid-terms then exacerbated those growth and inflation concerns. Bond markets remained fairly stable, but equities seesawed their way meaningfully lower through November. This culminated in one of the most abrupt reversals of Fed language from the past few decades, with Fed Chair Powell stating in late November that the neutral rate had now “almost been achieved”.

 

Reviewing this is useful because everything above is pretty much the textbook definition of how risk markets adjust to an interest rate cycle reaching middle age. Historically that has been a healthy process, setting the stage for equities to appreciate by mid-to-high single digits in the following year.

 

Price action in the days since Powell’s comments – and particularly since the Xi-Trump G20 dinner – have seen previous market relationships break down: for example, the USD is now strengthening despite rates falling; and defensive equity sectors have switched from negative to positive correlation with cyclical sectors. This somewhat more chaotic phase of a sell-off is, in my experience, a signal of its end; it tends to imply that investors are trading their P&Ls (profit-and-loss statements) rather than actual market fundamentals...particularly this close to year-end.

 

These disconnects have opened-up very interesting opportunities, primarily in equities but also in some other asset classes. Notwithstanding near-term issues like the arrest of Huawei’s CFO or this Tuesday’s Brexit vote in the UK, we are now actively deploying the cash that we have been carrying in portfolios since late summer. The medium-term risks of declining business confidence and/or wage inflation remain legitimate – but after a year where earnings have grown 20%+ and equity market returns are negative, these risks seem reasonably priced-in.