This week has been one of the worse this year and many have been left surprised about it since there was no apparent reason or news which prompted this sell-off.
In reality though, the investment environment has been slowly shifting over the past months and this has increased volatility. Below are a couple of reasons which are being attributed to this week’s bloodbath:
1) High Valuations
The S&P500 was up over 30% percent since January 2016. That's a massive jump in eighteen months. Historically, the stock market has gained 8%, on average, in a year. Investors were beginning to look around and question whether stocks really should be at such high levels.
2) Rising interest rates
The Federal Reserve has a dual mandate of maintaining full employment and keeping inflation in check. Lower levels of unemployment tend to push up inflation. Higher levels of interest rates decrease employment (or slow down its growth). The US economy is currently believed to be at full employment, leaving many to believe inflation to rise, thus the Federal Reserve is raising interest rates to combat such pressures.
Furthermore, after almost 8 years of expansion with low rates, the FED thinks it is necessary to begin increasing rates to prevent over heating of the economy.
This is all basically part of the economic cycle and sooner or later, it was bound to happen.
Of course, by increasing rates, US corporations will be affected because they will have higher cost of borrowing, which in turn effects their profits. Savers on the other hand will start depositing more money in banks, or in higher grade bonds which pay a better interest rate than what they used to do before. This is known as the great rotation in markets whereby investors start moving from Equities to Bonds as their appetite for higher risk/higher reward from stocks declines in favor of lower risk and not ‘anymore lower’ interest from safer investments.
3) Trade war looms
The trade war between the world’s two largest economies is starting to affect investors sentiment. Recently the IMF has actually cut its 2019 growth forecast for the US and China and this has created more uncertainty.
Although the US receive a boost from the tax cuts, this is not sustainable and the IMF is predicting economy growth to slow to 2.5% from 2.9% this year. China’s is now expected to drop to 6.2%, from 6.6% this year.
4) Tech stocks under siege
This is relevant to both point 1 and 3 as this sector was the one that got beaten the most. Several CEOs of large multinationals including Apple and Microsoft warned President Trump that trade ware with China will have a massive impact on their company’s health. This can be attributed to the fact that these firms use China as part of their production chain. Adding to this, we have also seen a massive rally over the past years into this sector and thereby making it the most vulnerable when things go sour.
Although this week has been really though for investors, we are still far-off from a bear market territory. Find out in this article here
Do you want to know how you can gain in a downmarket. Read our article here