Morgan Stanley
  • Wealth Management
  • Sep 4, 2019

Coping with Rising Economic Uncertainty

As geopolitical and policy uncertainty pick up, it can be tempting to react, but doing nothing may be the best course of action for now.

Lisa Shalett Chief Investment Officer, Wealth Management

Global economic uncertainty has been increasing in the past month and shows no signs of abating. Contributing factors include mixed signals from the Federal Reserve, stalled China-U.S. trade talks and potentially destabilizing geopolitical events in Europe, Hong Kong, Iran, Argentina and Brazil. The Baker, Bloom & Davis U.S. Economic Policy Uncertainty Index, a barometer of perceived uncertainty, recently jumped to a three-year high.

These risks haven’t had a major impact on the S&P 500, the benchmark of the broader U.S. market, which is down 4% from July’s all-time high but remains up 17% for the year to date through August. While economic uncertainty can become self-fulfilling, leading to decreased business and consumer confidence, I think investors should sit tight for at least the next couple of months and wait for clarity. Below are key areas to watch:

  • Fed Policy: Investors seem to be confident that the Fed will continue to cut interest rates to counter a global slowdown. But the Fed issued some contradictory guidance about its plans when it cut rates in late July. If the Fed shows any signs of increased hawkishness, investors may be disappointed.

  • Trade friction: Investors are expecting an eventual trade deal with China, but negotiations are stalled. While the likelihood of a constructive pro-growth resolution in the next 12 months seems to be dwindling, any improvement would be welcome.

  • Currency moves: China’s renminbi (RMB) has depreciated by about 5% against other major global currencies, over the past three months, a deflationary move that contributes to the relative strength of the dollar, making business conditions tougher for U.S. exports and emerging markets, many of which export commodities and other goods that are dollar-denominated. More RMB depreciation would likely spark worries about global deflation.

  • Geopolitical risks: Investors are now contending with a litany of global events, including rising odds of a no-deal Brexit, political unrest in Hong Kong, a threat of sovereign default in Argentina, new rhetoric around Iranian sanctions, a collapse of Italy’s coalition government and increasing anxiety about the long-term costs of fires in Brazil’s Amazon rainforest. Adverse developments in any of these areas could have implications for currency, bond, credit and commodity markets.

These risks have contributed to an increase in market volatility and are clearly reflected in global currency, bond and commodities markets. So far, U.S. stocks have benefited from a “buy the dip” mentality, but a worsening of geopolitical events or increased economic uncertainty that dents U.S. consumer and corporate confidence and leads to slashed profit forecasts could break that pattern.

For now, I think it’s best for investors to consider holding the course for at least the next six-to-eight weeks and watch for signs that policy clarity is helping to stabilize confidence. 

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.

Investing in commodities entails significant risks. Commodity prices may be affected by a variety of factors at any time, including but not limited to, (i) changes in supply and demand relationships, (ii) governmental programs and policies, (iii) national and international political and economic events, war and terrorist events, (iv) changes in interest and exchange rates, (v) trading activities in commodities and related contracts, (vi) pestilence, technological change and weather, and (vii) the price volatility of a commodity. In addition, the commodities markets are subject to temporary distortions or other disruptions due to various factors, including lack of liquidity, participation of speculators and government intervention.

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