September is here and that usually means market volatility. This year is shaping up to be a classic. A looming confrontation in Syria is high on a list of risks, but pivotal for investors will be the US Federal Reserve’s policy meeting in the middle of the month and a decision on whether the time is right to start trimming its monetary stimulus.
“The move to tapering is a sea change,” said Sandra Crowl, a member of the investment committee for fund manager Carmignac Gestion.
“This would be the end of a 20-year US bond market rally, and the end of what has been multiple years of liquidity being injected into the US economy that has found its way into emerging markets.“
If that was not enough to spark nervousness, the Fed’s decision comes as questions are being asked about China’s slowing growth and as Europe and Japan battle to pull away from long-running recessions.
That September is often a volatile month for investors has been well documented.
Data on the Dow Jones industrial average, going back to 1896, show September has historically been the worst month of the year, according to BlackRock chief investment strategist Russ Koesterich.
Historically, September was also the worst month of the year in several European markets and in Japan, Koesterich said in a note.
Markets are already on edge after the Chicago Board Options Exchange volatility index jumped more than 20 percent to a three-month high last month when it emerged that Western nations were considering military action in Syria.
September’s volatility trigger is likely to be the US Treasury’s 10-year bond yield. It spiked by almost 50 percent during the northern hemisphere’s usually quiet summer months to sit near 3 percent, from just under 2 percent in early June.
Asset managers say it is not just how high the yield has risen but the speed of the move and its potential to overshoot that is the main risk.
“Interest rates are the biggest visible pothole in the investment road,” Kevin Gardiner, the head of investment strategy for Europe at Barclays Wealth, said.
If the US economy can bear the weight of higher interest rates, bigger flows into developed world equities seem most likely.
Under this scenario, Europe is still the favoured destination due to signs of economic recovery, despite stocks there recently outperforming other major developed markets.
The broad Stoxx Europe 600 index dipped 0.35 percent in August as all risk asset markets were hit by a flare-up in the Syrian crisis, compared with a drop in Wall Street’s Standard & Poor’s (S&P) 500 index of about 2.8 percent.
The fact that the Stoxx Europe index rose only about 7 percent this year means it has potential to gain.
Patrik Schowitz, the global strategist for JPMorgan Asset Management, sees another attraction: on a price-to-book valuation, European shares trade at a 25 percent discount to their historical average.
Their current price-to-book ratio is 1.6 times, against a 25-year average of 2.1 times, while emerging market equities are on a ratio of 1.5 times – an 18 percent discount to their 18-year average of 1.8 times.
It is in emerging markets where volatility could be most felt. Flows out of emerging market equities picked up last month in anticipation of a Fed tapering move. Outflows from emerging market equity funds more than doubled in the last week of August to a net $3.9 billion (R40bn), investment banks said on August 30.
Asset managers fret that if US interest rates rise too far, these outflows will only accelerate.
In the longer term, however, if the Fed strikes the right balance between tapering stimulus without jeopardising the recovery, then a global pick-up in economic activity would be more likely and the view on emerging markets could shift.
“Emerging markets have become largely unloved and sentiment towards them overly negative,” Kleinwort Benson chief investment officer Mouhammed Choukeir said.
“Fed tapering could add some more downside pressure, but given where valuations lie, they could represent a better opportunity than some developed markets,” Choukeir added. – Richard Hubbard for Reuters