The JP Morgan Global and Services Purchasing Managers Index (PMI) was released on Monday afternoon and indicated global economic growth at a 40-month high in January, while forward-looking indicators suggested that the strong growth will be maintained for some time.
Although global government bond rates have been in a strong upward trend since December the PMI indicated that the global economic situation is consistent with above potential real gross domestic product growth and that the danger of overheating is real.
Stocks, and especially economically cyclical equities in developed markets, are at risk due to rising interest rates that will undoubtedly threaten the rich valuations of equities, especially in the US markets.
While a cut in company tax rates in the US is likely to underscore earnings growth, the big question is whether the global economy will catch up with the current levels of global equity markets.
The Chicago Board of Exchange’s volatility indicator VIX - also termed the “fear” indicator by the market - swung to 37points on Monday from 13points last Friday. Yes, from euphoria to fear.
Investors’ optimism has reached a point where they were and still are euphoric that the above-average returns will continue for ever.
This feeling good stage is the stage when investors face maximum financial risk.
Turning points in the markets are mostly event-driven such as Gray Rhinos or Black Swans. The anxiety caused by the events makes investors unsure as to where the market is heading next and they opt to rather sit it out.
Currently it is a Gray Rhino, a term coined by Michele Wucker, where in simple terms she means why “do we ignore problems when the costs and consequences of failing to act are obvious?”
Everybody knew that interest rates, long and short-term, will eventually rise, but the question was when. The hawkish stance by central bankers in developed economies is likely to gain momentum as inflation expectations are likely to increase.
The normalisation of monetary policy, especially in the euro zone, will probably be brought forward.
The US economy is currently in “full employment”. In normal circumstances the Fed would have started to raise interest rates quite aggressively, but at this stage they are still dovish.
Furthermore, the US is still pump priming the economy as real short-term interest rates (nominal interest rates adjusted for inflation) are still negative.
With inflationary pressures rising (commodity prices, increased demand for goods and services in the euro zone and China) and the prospect of higher wage demands in the US, the next step will be to hike the Fedfunds rate by as much as 100 basis points during the course of the year with the same or half of it to come in the first half of next year.
We are entering the late stage cycle in the US economy.
Whether the markets will recover and by how much is unknown or denial, fear and panic.
The reality is that we should expect more volatility and difficulty in meeting our investment return goals this year, and next. Revert to the mean, they say.
Ryk de Klerk was co-founder of PlexCrown Fund Ratings and is currently a consultant for PlexCrown Fund Ratings.
The views expressed in this article are not necessarily those of the Independent Group.
- BUSINESS REPORT