Morgan Stanley
  • Wealth Management
  • Sep 23, 2019

U.S. Markets Are Resilient Now, But What Comes Next?

The S&P 500 continues to mostly recover quickly from setbacks, even in the face of new risks, but that tendency is unlikely to persist indefinitely.

Lisa Shalett Chief Investment Officer, Wealth Management

All year, markets have remained surprisingly resilient in the face of troubling developments, both domestically and internationally. Most recently, we’ve seen volatility in oil prices, policy disagreements within the Federal Open Market Committee (FOMC), the rate-setting arm of the Federal Reserve, and liquidity problems in very short-term fixed income markets. These developments come on top of ongoing uncertainty created by U.S.-China trade tensions and other geopolitical risks.

The S&P 500 has quickly bounced back from each news-driven decline and is up 19% year-to-date, near record highs reached earlier this year. While some investors see this resilience as cause for bullishness, I remain cautious. Important questions loom. Below are three new areas of concern that may well lead to more volatility:

  • Oil market disruption: Attacks on Saudi Arabia’s oil fields led to concerns about supply risk and caused a large one-day spike in the price of oil, which then retreated, as investors were reassured that a long-term shock to oil prices was unlikely. Is it really that simple? I think Middle East tensions are intensifying and related oil market dynamics are complicated. Further oil market disruption is a possibility.

  • Lack of unity on Fed: The FOMC voted to cut rates again at its mid-September meeting, as expected. But there was an unusual lack of consensus. Three members dissented. This is one reason that volatility in interest rates has spiked. Since September 1st, the benchmark 10-year Treasury yield has rapidly climbed from 1.4% to 1.9%, and then retreated to 1.75%. Those are big swings for bonds.

  • Upheaval in money markets: The very short-end of the bond market has been even more turbulent recently. An overnight lending rate spiked and the Fed had to step in to restore liquidity to the so-called repo market. While this was a technical problem more than a problem in the banking industry, it does make me wonder why the Fed didn’t anticipate this event and what it will do if it can’t control short-term interest rates in the future.

While at the index level, U.S. markets may seem calm lately, a lot of turmoil lies just below the surface. The good news is that diversification is working: When Treasury prices fell, stocks rose, sheltering investors who own both asset classes.

Investors should strive to be highly diversified by asset class, geography and sector, favoring active management and high quality, income-producing securities that are more likely to hold up if complacency fades. The fact that the stock market is shrugging off the latest round of macro risks this late in the business cycle makes me cautious, not bullish.

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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