Vive la difference

September is traditionally a dodgy month for stock markets and this one has not started too well. Weak emerging market currencies and a stronger dollar providing the tension. The Vix index climbing above 14 emphasises the point that fear feels like its entering the fund manager psyche. US treasuries which often become a safe haven in these times likewise saw something of a selloff as the 10-year maturity hit 2.9%, post some better than expected economic data. Equity markets in Europe broke down below the bottom end of there trading ranges. All this did not stop Amazon from becoming the second US company to hit the trillion-dollar valuation. 

So far US equity markets have remained remarkably resilient to the stronger dollar as the economic data remains supportive, however one feels that this cannot last. Historically US equities do not outperform those around the globe during these periods. The gap between the performance of developed equities against US ones is at historic extremes. This may be partly explained by the exaggerated influence the technology sector has on US equity indexes. 

Neither interest rates in Europe close to zero or many UK companies offering dividend yields more than 5% have provided much of a backstop in recent weeks. 

The gap between the performance of the rest of the developed world will narrow at some point, the question is how? It is hard to believe that a sudden selloff in US equity indexes will not be reflected in the performance of the rest of the developed market. It is also hard to believe that developed equities will suddenly start to outperform on the upside unless US ones can continue to rise. As the technology sector continues to power ahead, the Nasdaq index up circa 17% this year, on top of solid gains in previous years, there must come a time when at the very least a correction is in order. Perhaps that will be the catalyst for the performance difference to come closer into line. 

We have previously highlighted how the capital market cycle works historically. First credit rises then equities start to perform as we exit an economic recession. Then credit markets fade, equities continue to rise for a while, then both fall as we enter a recession before the cycle repeats itself. At present equities, at least US ones remain stable, credit markets have softened but the gap between investment grade and corporate credit has widened but remains below historical averages. 

Posted on September 4, 2018 .