US market sell-off: Multi-Asset Strategy Update

A rather long list of risks, combined with an extreme positioning, triggered an equity market sell-off in the US on 10 October. We had started reducing our equity exposure since the beginning of October and are now neutral equity. As of now, we are not changing our constructive mid-term view on equities.

MARKET OVERVIEW

On 10 October, both the Dow Jones Industrial and Nasdaq sold-off, dropping more than 3% and 4%, respectively. There was no single catalyst for the sharp sell-off, but rather a long list of risks, coupled with extreme positioning. In recent months, diverging performance between the US and the rest of the world has become extreme, leading trend followers to hold very long positions on US equities and growth stocks, particularly in the technology sector.

Similar to what happened earlier this year in February, the decline in market prices coupled with the rise in volatility observed since the end of last week triggered stop-losses in systematic funds, leading to significant outflows and the sell-off with almost no equity buyers present, as Long Only funds and corporates (through buy-backs) have not started buying yet.
There was thus no fundamental reason for the strong market decline, though macroeconomic risks are still present. We have isolated two risks. Firstly, from the Fed's perspective, the market is slightly off record highs, so the Fed has no reason to deviate from the gradual hiking path. Secondly, the US-China trade conflict has escalated significantly.

WHAT'S NEXT?

Beyond valuation, there are potential performance triggers, in particular the start of the Q3 earnings season, forcing market participants to look at fundamentals. The re-start of stock buybacks in the coming weeks post-blackout period in the US could also be a positive catalyst.

Despite the increased volatility and more challenging market circumstances, we haven’t changed our constructive medium term view. We will be opportunistic and re-assess our positioning when we identify a possible turning point, which may not end up being that far from current levels.

CONSTRUCTIVE MID-TERM VIEW

Fundamentals, which are key for market performance, are still supportive. The business cycle is still moving forward, corporate earnings are still growing and equity market valuations look relatively attractive. Our 1-year expected returns are even close to double-digit growth for equities. From a medium-term perspective, we still believe there is more potential in the Eurozone and Emerging markets, given the higher risk premium.

The main risks to our bullish moderate equity scenario include a sudden halt to the current expansion, extreme tightening of USD liquidity and spiralling geopolitical tensions. In the meantime, we are maintaining a short duration to limit the impact of interest rate volatility, and a negative tilt on bonds with the exception of emerging market debt.