Market Comment - US yields stir markets

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Equity markets have been under pressure for the last few days, with an acceleration on Wednesday. The S&P500 and Nasdaq dropped respectively by 3.3% and 4.1%. Most likely triggered by US Treasury yields, that rose last week to the highest level in years.

Financial markets worldwide showed losses. European equity markets fell by 2% and emerging markets, in particular Chinese stocks, remained under pressure on Thursday morning. The Shanghai stock market was down almost 6%.

On Wednesday, significant profit taking on crowded stocks was registered: in Europe, luxury stocks dropped, with Kering and LVMH falling respectively by 9.6% and 7.1%. In the US, technology stocks registered losses, with Netflix and Amazon giving up respectively 8.3% and 6.1%. Apple and Microsoft decreasing more than 4%.

Spiking US yields

The 10-year US Treasury yield reached 3.21% last week, a level that was not seen since 2011. Consequently, Asian and European government bond yields went up as well. These high US Treasury yields were caused by a combination of strong US numbers and a firmer tone in recent comments of the US Federal Reserve (the Fed).

Rising interest rates are negative for stock markets, as the borrowing costs go up and interest rates are used as a discount factor in valuation models. Higher interest rates make stocks more expensive. The risk of higher rates going forward, contributed to the current market turmoil.

We do not share the fear of much higher interest rates. As fiscal stimulus will fade in 2019 and inflation remains well contained, we expect the Fed to stop hiking rates at 3% in June next year. That level should also serve as a guide for 10-year US Treasury yields in 2019.

Volatile, despite good fundamentals

Another contribution to the turmoil may be found in the political risk regarding the trade conflict. There is no clear sign of a solution - in fact, the rhetoric of the Trump administration towards China is becoming more and more tense. Together with the rising US yields, this weakened the sentiment in financial markets.

We expect financial markets to remain volatile in the coming days, however, economic fundamentals remain good. The US economy is doing well with growth of around 4.2%. European and emerging economies are currently in a soft patch. The expected strong earnings results should reinsure investors.

On top of market developments

At this moment, we have a moderate overweight position in equities, with a preference for the US market over Europe and a neutral stance towards emerging markets. On IT and consumer discretionary, we remain neutral. We do not see the current correction as a significant buying opportunity. We will monitor the financial markets closely and will update you on market developments when this is needed.

Richard de Groot
Global Head of Investment Centre

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