Three potential reasons for the market drop

In this week’s video update:

  • Three potential drivers for this week’s equity market drop.
  • Does a close call by the U.S. Federal Reserve (Fed) in September point toward a likely rise in December?
  • A potential rally in emerging markets? See the indicators.

On this week’s update, Director, Investments, Investments Practice Bindu Sutaria met with Investment Strategist, Paul Eitelman to discuss what might have caused this week’s market volatility.

Kicking off the update, Eitelman noted that the S&P 500® dropped one percent relative to last week, and believed three main drivers potentially caused this:

  1. Interest rates have been gradually moving up in the U.S. The 10-year U.S. treasury yield is at about 1.75 percent right now. Eitelman noted that as the highest it’s been since the surprise Brexit vote in the UK and believes those rising rates acted as a headwind on the defensive and rate-sensitive components of the equity market.
  2. With the run-up in rates, the S. dollar has also been strengthening and is now at its strongest level since March of this year. That creates an additional headwind for both the earnings outlook and the economic outlook in the U.S.
  3. And speaking of earnings, the third quarter earnings season is getting underway. Eitelman thinks there is investor angst on how these reports will impact the U.S. equity market: We know that equity markets valuations are expensive. To either sustain those valuations or hit new highs, Eitelman believes very positive earnings numbers need to come through.

Also this week, the U.S. Fed released notes from their September meeting and revealed that their recent vote was a closer call than expected to not hike rates in September. As U.S. labor markets improve and U.S. inflation slowly moves up to two percent, Eitelman noted that Russell Investments’ strategists are more confident than ever that the Fed is getting closer to a rate increase. The strategists still believe the rate increase will hold off until December, after the outcome of the U.S. presidential election and the potentially volatility-inducing Italian referendum.

On the emerging markets (EM) front, Eitelman noted some less-than-impressive import/export numbers coming out of China. However, he remains bullish on emerging markets. He noted that EM exchange rates have fallen so much on a year-over-year basis that emerging markets are much more competitive now. In Russell Investments’ view, the EM business cycle is becoming less negative, and EM as an asset class continues to seem like a bargain.

To read more about a potential emerging markets rally, see our recent blog post by Rob Balkema.

Watch now.