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#Market Strategy — 11.10.2018

A Big Market Sell-off: Is this the End of the Cycle?

Grace Tam

Global equity markets saw a sharp sell-off last night with S&P 500 -3.3%, Nasdaq -4.1% and Euro Stoxx -1.7%.

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Global equity markets saw a sharp sell-off last night with S&P 500 -3.3%, Nasdaq -4.1% and Euro Stoxx -1.7%. The VIX Index jumped 44%. Asian equity markets have extended the sell-off this morning with Topix -3.9% and Hang Seng -3.7% (as of writing). Safe-haven assets have seen demand with US 10-year Treasury yields falling to 3.15 from 3.23 (yesterday), Japanese yen strengthening to 112.11 vs USD from above 113 levels (yesterday). 

What contributed to the corrections? 

  • The sharp rise in US yields after the hawkish comments from the Fed officials last week has since unsettled the financial markets. Continued strong US data have added to the concerns about the US interest rate outlook.
  • The IMF cut its global growth forecasts for the first time since July 2016 and gave warnings about trade tensions and financial stability risks.
  • Renewed concerns over the impact of the escalating Sino-US trade conflicts on the technology sector
  • A crackdown at Chinese borders on undeclared luxury goods which deepened a sell-off across the global luxury sector

This is NOT the End of the Cycle 

There is no change in fundamentals. The recent rise in US yields is actually in-line with our long holding view that US yields would go higher. We still believe the most of the interest rate hikes are behind us as there is no acceleration in inflation and economic growth is set to slow in 2019. We maintain our view that the Fed will have one more hike in December 2018 and two more in 2019. Therefore, we have not changed our 12-month target for the US 10-year Treasury yield i.e. 3.25% but expect an overshoot in the coming months. 

We have maintained a neutral stance in US equity and global technology sector for a period of time as the rally has been extended and they have been overbought in the short-term with relatively expensive valuations. This is a much needed correction to remove some of the “froth”.   

We expect volatility to continue in coming weeks and months as long as short-lived risks persist. However, the late cycle and the medium-term bull market is not over. Three key fundamental reasons to explain our optimism: (1) We expect to see continued increase in company profits in 2018 and 2019; (2) US rate hikes are likely remain gradual; and (3) equity valuations have come down – the US market remains relatively expensive compared to historical standards and its peers, but its valuation is less tight than year ago, thanks to strong profit growth. Therefore, nothing has happened so far that have undermined these three solid arguments.