From peak to trough, the S&P 500 fell 10.2% this month, while the VIX volatility index spiked to multi-year highs. We believe that the sell-off itself was largely technical in nature, driven by forced selling among investors employing systematic strategies. From here, provided the fundamental economic and earnings growth picture remains unchanged (we forecast 4.1% global GDP growth and 16% US earnings growth), we should be confident that the market will eventually regain its footing.
So a key issue in the weeks ahead will be whether the market sell-off might have led economic fundamentals themselves to deteriorate. We will continue to monitor the potential feedback loops from market turmoil into the real economy, but for the moment the impact on consumption and investment from the recent turmoil would seem limited:
- Until the recent decline, the S&P 500 had gone 404 trading days without a 5% pullback, its longest run since the 1950s, and with Monday's rally US stocks are still up 10% and 17%, respectively, over the past six- and 12-month periods. Thus, in our view, the falling equity values are unlikely to lead to a significant negative wealth effect.
- Investment grade (IG) credit spreads have widened by just six basis points (bps). The move in high yield (HY) spreads widened by much less than would be expected given the equity move (60bps), and started from close to the lowest levels since before the global financial crisis, so spreads are still just 382bps.
- Although the overall cost of borrowing is rising due to higher government bond yields, the impact of higher rates on companies will take time to feed through. Over the next two years, we estimate that only 10% of outstanding US IG bonds and 5.5% of US HY bonds need to be refinanced.
We remain overweight global equities.
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