8th February 2018

Royal London: Starting to buy the Donald Dip

US stock market volatility continues to spike higher as the strongest wage inflation in the US since 2009 triggered fears of faster than expected rises in interest rates. While Donald Trump’s White House has correctly pointed to strong economic fundamentals as a more important long term story and the role of the tax cuts in driving this, they’ve failed to appreciate the impact that their policies could have on inflation, and therefore the path of interest rates. 

However, current market weakness should be put in its proper context, with the sell-off to date merely reversing a rally through December and January driven in part by excessive investor bullishness.

After several weeks of exuberance, our composite sentiment indicator is now heading for its most negative reading since China’s devaluation panic in the summer of 2015 [Chart 1] but fundamentals remain strong. The world economy is growing strongly, corporate earnings are being upgraded and equity market valuations are becoming less heady as prices drop.

Trevor Greetham, Head of Multi Asset at Royal London Asset Management, said:

“The reaction from the White House to yesterday’s moves suggests that they’ve failed to grasp the significance of their own policy as a catalyst for this sell-off. Investors welcomed the announcements of tax cuts but are starting to get second thoughts as the consequences of adding stimulus late in the business cycle become clear. Unemployment is low and the potential for strong wage inflation once US tax cuts take effect has spooked markets, given what this means for US interest rate policy.

“Although rising interest rates pose a challenge to the stock market, this will only become a serious one once they are high enough to cause the economy to roll over. With the Fed Funds rate still below the level of core inflation in the US [Chart2], that could take quite a while.

“We expect bouts of volatility like this to become more common now the Federal Reserve is in play, but expect stocks to recover over the coming weeks and months, making recent market moves look like an overreaction.

“It almost always pays to buy stocks during a panic. We lightened up equity exposure in our funds last week, while remaining overweight. With markets at lower levels, we are looking to add to these positions again as the sell off progresses.”

CHART 1

CHART 2

Investments, Protection