As the current market cycle looks ever longer in the tooth, many investors will be reviewing their regional exposures over the coming months.
But when thinking about the range of headwinds facing global asset classes – from geopolitics, to monetary policy, to DM-EM currency dynamics – it is interesting that so many of them find their key causes or catalysts in the US.
When allocating to regions around the world, it is worth remembering the US’s influence further afield.
In this context, the health of America has a significant impact on the health of global markets – so any signs of pain here could spell bigger trouble elsewhere, and potentially fairly quickly.
US dollar strength has some of the most direct implications for global regions, particularly emerging markets.
President Donald Trump’s meeting with North Korean leader Kim Jong-un recently was another reminder to investors not to second guess the direction of US foreign policy.As the dollar climbed even further this month after a dovish announcement by the European Central Bank left the euro exposed, this continued strength is a substantial challenge for EM economies.
Central banks in Turkey and Argentina, for example, have had to raise rates to protect the value of their currencies, weakening growth in the process.
These countries are particularly fragile, but this effect has the potential to spill over to other parts of the EM complex – and we are seeing some countries beginning to take precautionary measures, like Indonesia, which raised its rates in May.
Rising US yields are another important dynamic, with the US Federal Reserve continuing its tightening path, and unsurprisingly raising interest rates again this month.
As the yield on 10-year US Treasuries recently crossed 3 per cent (an important inflection point for markets, if only for reasons of psychology), the pressure is mounting on equities as investors use this as a higher discount rate to compare against their future cash flows.
For many investors, the narrative of low interest rates has been a prevailing force behind high valuations, and markets are watching closely for signs of a ripple effect across markets as the cost of servicing debt continues to increase.
Chart: US 10-year yield
Source: Bloomberg, SPX Index and USGG10YR Index, as at 18 June 2018.
The third, and perhaps least predictable of these US-influenced dynamics is geopolitics.
President Donald Trump’s meeting with North Korean leader Kim Jong-un recently was another reminder to investors not to second guess the direction of US foreign policy.
Over the coming months, America’s international relationships are likely to matter more than ever. From trade, to oil, to national security – there are no shortage of risks, and events around each of these have the potential to trigger periods of market volatility.
Ultimately, while the US has been the clear leader of the global recovery following the financial crisis a decade ago, and we see no immediate reasons for a turnaround in the coming months, it is important to remember that its stock markets have been driven upwards by an extremely narrow set of names.
Many of these could face significant risks in the near future, particularly if the current tech cycle rolls over, leaving US equities vulnerable.
While the country’s macroeconomic data remains robust for now, it is worth remembering the old adage that when America sneezes, the world tends to catch a cold.
Bill McQuaker is portfolio manager of the Fidelity Multi-Asset Open Range
