Financial markets and the recent disruptions

To date, 2018 can be marked as one of the most volatile years in history as the market disruptions experienced so far have been way above what market participants were expecting. Interest rate hikes in the U.S. were one of the sole convictions amongst market participants. It’s no secret or no doubt was put forward that eventually the Federal Reserve (Fed) would commence increasing rates, the sole doubt was the pace of the hikes. The U.S. economy is doing well, the unemployment rate is at record low levels, wage growth has ticked upwardly and inflation levels are close to target. So far so good for the U.S. economy. Europe also seems to be on a recovery path, so why should investors experience all these remarkable bounces? The market disruptions being experienced so far have been triggered by several unexpected events. The intra-day market swings seen lately are insensible, however concerning for those investors who panic when they see capital erosion.

The trade war

We believe that the trade war between the U.S. and China is one of the prime contributors for this year’s volatility. Despite Trump’s administration continuing to bully China, metaphorically speaking, the Chinese continue to hold-on to their stance of being rebellious. We think that what bothers the U.S. most is the continuous deficit figures with China that were consistent for the past years. Just to put you into perspective in 2017, the U.S. had a trade deficit with China of circa $375bn. To date the deficit is around $261bn with two months to go. So yes the sustained levels of deficit are tedious and Trump, as promised, is tackling the situation. To be fair, the tariffs being imposed by China vs the U.S. are single high digits as opposed to the low single digits being imposed by the U.S. on China. So yes, in all fairness Trump is right in being irritated. What market participants dislike is Trump’s approach.

Given that China is the second largest economy and markets use China as a barometer for demand, the trade war is a concern that the region will fail to sustain its mid-sixes levels of growth. We are of the view that eventually a solution suiting both parties involved will be found, as ultimately both stand to lose. The economic theory put forward by few economists stating that in a trade war nobody is a winner, I believe stands right in the circumstances. It’s a state of fact that free trade has over the years proved to have boosted the world economy.

The Turkish saga

This was another unexpected event that triggered yet another sell-off in emerging market economies. Trump imposed tariffs on Turkey following the failed release by the latter of an American pastor. The Turkish lira plunged, a move, which triggered a contagion effect amongst others on other EM currencies such as the Indonesian rupiah, the South African rand.

Here Trump triumphed, as the American pastor was released 12 days ago, a move which prompted soaring levels in the Turkish lira with Turkish assets following suit.

Argentina and its financial uncertainty

Following an upgrade a year ago to B+, due to improving financials and economic momentum, Argentina returned back into dire straits. Argentina's recession-laden economy is struggling under steep interest rates and a currency that has lost around 50 percent of its value against the dollar this year alone. A concern which triggered a bloodbath in Argentinian assets, which also prickled negatively to other EM nations as many feared yet another default. Luckily enough the International Monetary Fund (IMF) returned once again to the rescue with an increased bailout to USD57.4. A move managed to tranquil to a certain extent market participants.

The Italian insensibility

Closer to our waters, Italy was one of the biggest underestimations by market participants. The coalition government, a populist government, has put forward a budget plan for the European Commission’s approval which is from many fronts one that provokes the economic sustainability of Italy. A budget plan which was rejected by the commission and which triggered a sell-off across European assets. The uncertainty surrounding Italy and its political uncertainty is underpinning the possibility of another election in the coming months.

Not to mention Brexit, the above mentioned events have characterized the market volatility so far. In such circumstances, investors are in an awkward position of whether to hold on to their investments or whether to cut the loss. In reality, the market noise experienced to date is not based on fundamentals and to this extent we question why markets have brutally reacted in such manner. Our views would be different if fundamentals are weak or if data points are pointing to a recession. However, the situation is different and we believe that the market movements are unjustified. For those in, hold-on. For those sitting on cash, it might be worthwhile taking the plunge.