Monthly viewpoint

December volatility: what’s causing it and what it means

Anxiety over the prospects for the US economy is one of several factors driving market turbulence

06/12/2018

Christopher Lewis

Christopher Lewis

Investment Manager

Following the G20 trade truce between the US and China, equity market investors may have been looking forward to a more settled end to the year. But the start of December has brought further volatility as fresh fears surface about the fragility of the trade truce and the outlook for the US economy.

The arrest on 1 December in Canada of the Chief Financial Officer of Chinese telecoms giant Huawei, over potential violation of US sanctions on Iran, has cast uncertainty over whether a working agreement can be achieved. Fears of a protracted dispute continue to spook markets.

Key economic signal flashes a warning over US growth

The “yield curve” is a key investor gauge of the outlook for an economy and in recent days the US yield curve has performed in a way which is traditionally perceived as negative.

In normal market conditions, it should cost less to borrow money for shorter periods, such as two years, than it should for longer periods such as ten. This is partly because of the potential impact of inflation on the fixed returns of a bond over time: investors want compensation for the extra risk. As a result, shorter-dated government bonds usually have a lower yield than longer-dated ones, and the shape of the yield curve tends to slope upwards.

An “inverted yield curve” occurs when shorter-dated bonds yield more than longer-dated bonds and indicates that investors expect falling interest rates, lower inflation and slower economic growth - in other words, a recession.

An inverted yield curve has preceded every economic recession in the US since the Second World War. It is understandable why the shift has sparked anxiety.

How concerned should investors be?

It is important to recognise that an inverted yield curve is a leading indicator. While it may warn of slower future growth, it does not reflect the present state of the economy. Indeed, since 1950, the average time lag between the yield curve inverting and the economy subsequently slipping into recession is calculated at 19 months. During those periods the S&P500 has risen by up to 21%.

While cognisant of the increasing threats to global growth, and conscious of the signals we are getting from leading economic indicators, we remain happy to maintain our neutral equity positioning across portfolios.

Author

Christopher Lewis

Christopher Lewis

Investment Manager

Chris joined in 2010 and is currently an Investment Manager. He has an undergraduate degree in History from Cambridge University as well as a Graduate Diploma in Business and Management from the Judge Business School and holds the CISI Masters in Wealth Management.

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