The rising interest rate environment – along with geopolitical shifting – is still sparking volatility in global equity markets, with the largest impact felt on bonds and emerging market securities. Looking forward, we can expect more of this volatility, driven by geopolitical inconsistency and rising yields, but we do expect the solid economic data to continue driving growth forward. The ups and downs can seem hard to stomach, but this trend is becoming a new normal. With positive fundamentals guiding us forward, it’s worth the ride.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index
As we’ve said before, a rising interest rate environment promotes volatility. This month’s geopolitical changes seem positive overall; however, a closer look reveals a longer-term trend of inconsistency. Two top items are the decreased risk of nuclear war at the Korean DMZ, and the recent leaning from President Trump towards opening trade – indicating favour to NAFTA and the TPP. While these are positive developments, we should take them with a grain of salt as both regimes are known for quickly changing course; Trump in particular is encouraging trade barriers on several other fronts. Given the flip-flopping, we think this volatility will continue.
Demand for low risk assets is down in the US, which means money is moving back into risky assets. Fundamentals have stayed strong, while investment in productive assets is growing at an annual rate of 6.1%, employment cost is showing its strongest gain since 2008, and corporate earnings have maintained their run with S&P 500 companies (which are currently on track for 25% year-over-year gain). The fact that the Federal Reserve is tightening the balance sheet while GDP is growing proves that this growth is driven by fundamentals and consumer confidence, rather than the fabricated liquidity pumped in by the Fed.
For the first time in four years, yields on the US 10-year treasury bonds have climbed passed 3%. It’s safe to say the Federal Reserve’s plan to increase short-term interest rates is piggy-backing on the rising confidence in the economy. Another positive development this month was that longer-term interest rates grew faster than shorter-term rates, a sign that confidence in the future is improving.
Higher interest rates mean higher borrowing costs, which will put pressure on corporations who rely heavily on debt on their balance sheets.As a result, the path forward will be a volatile one as corporations look to adjust the mix between debt and equity on their balance sheets.
At the end of the day, our global outlook is the same: we expect a lower growth environment and sustained volatility. What does this mean for you? Understanding how market fluctuations tend to play out can help you make more rational investment decisions, such as setting up pre-authorized contributions to benefit from volatility. While it can take some courage to ride a roller coaster, when you look back it was worth the ride.