Morgan Stanley
  • Wealth Management
  • Dec 10, 2018

Understanding Market Crosscurrents

Investor sentiment is veering between optimism and pessimism, creating extra volatility.

Lisa Shalett Wealth Management Head of Investment & Portfolio Strategies

What a difference a week makes! Just days ago, investors seemed overly optimistic about the benefits of a subtle shift in Fed policy. Now they seem way too pessimistic about the potential for a slowdown in global economic growth.

Last week, the S&P 500 fell more than 4%, erasing gains from recent rebounds and returning to the lowest levels we’ve seen this year. Catalysts included China trade policy worries, lower oil, a flattening yield curve and weaker than expected job figures.

Investor worries aren’t going away soon. But recent events don’t portend the kind of market downturn investors seem to fear. Below are five reasons why I think investors are too pessimistic at this point in time:

Global growth may be about to turn up. Believe it or not, there are signs of stabilization in emerging markets and China. Manufacturing is actually turning up overseas and in the U.S. Recent consumer spending figures suggest a strong holiday season. Global growth has been slowing, but the economy is still a long way from dipping into recession.

Falling oil prices don’t seem a result of slowing growth. As I wrote recently, oil is falling mainly due to a surge in supply, not a major drop in demand. I expect the economic interests of major oil producing countries to eventually lead to production cuts that stabilize prices.

Inverted yield curves are very early warning signs. This indicator, based on the Treasury market (where yields on short-term rates are higher than longer term rates), is considered a fairly reliable indicator of recession. But I would note that it is a very early warning sign, which tends to precede recessions by about a year and a half. 

Corporate fundamentals have little to do with the declines in stocks. While I expect earnings estimates to come down in 2019, they haven’t yet.  A recalibration may be in order, but that’s not what we’re seeing now.

Gold (the ultimate fear gauge), is not rallying. The fact that other asset classes, like gold, are not responding to the downturn suggests to me that we are not at a major inflection point. Gold is up only a dollar per ounce over the last month.

I don’t believe this is a time for investors to panic and sell. Nor do I think it is a good time to jump in and buy. We may well see lower lows and higher highs. Instead, I continue to believe that investors who are patient now will eventually be rewarded.

Risk Considerations

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision. 

Equity securities may fluctuate in response to news on companies, industries, market conditions and general economic environment.

Bonds are subject to interest rate risk. When interest rates rise, bond prices fall; generally the longer a bond's maturity, the more sensitive it is to this risk. Bonds may also be subject to call risk, which is the risk that the issuer will redeem the debt at its option, fully or partially, before the scheduled maturity date. The market value of debt instruments may fluctuate, and proceeds from sales prior to maturity may be more or less than the amount originally invested or the maturity value due to changes in market conditions or changes in the credit quality of the issuer. Bonds are subject to the credit risk of the issuer. This is the risk that the issuer might be unable to make interest and/or principal payments on a timely basis. Bonds are also subject to reinvestment risk, which is the risk that principal and/or interest payments from a given investment may be reinvested at a lower interest rate.

Asset allocation and diversification do not assure a profit or protect against loss in declining financial markets.

Rebalancing does not protect against a loss in declining financial markets.  There may be a potential tax implication with a rebalancing strategy.  Investors should consult with their tax advisor before implementing such a strategy.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies.  Technology stocks may be especially volatile.

International investing entails greater risk, as well as greater potential rewards compared to U.S. investing. These risks include political and economic uncertainties of foreign countries as well as the risk of currency fluctuations. These risks are magnified in countries with emerging markets, since these countries may have relatively unstable governments and less established markets and economies.

Investing in foreign emerging markets entails greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks.

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