Ugliest month for Aussie stocks since 2015

The energy sector has also fallen short this month with Brent crude down 6.7% and WTI down 9.3. Commodities, as Saxo Head of Commodity Strategy Ole Hansen recently noted, have failed to defend the global equity rout against their own backdrop of rising rates, stronger dollar, and concerns regarding global growth and commodity demand.

As oil prices increased and Brent crude hit highs of $86/barrel in early October, the risk of demand destruction rose as well, particularly within the emerging economies that account for a large proportion of demand growth for oil. For example, in India, given the strong USD and rupee depreciation year-to-date, the price of oil in local currency terms has risen to levels not seen since 2014 when oil was trading above $100. Throw in Saudi Arabia’s pledge to produce as much as possible and Opec’s concerns about oversupply and we have seen a dramatic turnaround from the $100/b oil forecasts seen not so long ago.

Higher bond yields also start to call into question positioning in equity markets and asset allocation more broadly as risk premium rises and yields approach levels that start to compete with dividend yields, meaning that risk reward becomes less attractive for equities in general. For a conservative investor, the yield on a two-year note or one-year bill for a conservative investor is getting to levels where it can compete with stocks’ dividend yields, bringing about a seismic shift in asset allocation that only adds pressure to equity markets. The ‘buy the dip’ strategy that has worked all year is now much riskier.

Investors will be rewarded for positioning cautiously against this backdrop and overweighting defensive sectors within equities. In terms of factor exposure, we see sentiment tilting towards low beta/minimum volatility, quality, and value (which can be played through ETFs and by reducing exposure to high PE, momentum, and high beta positioning). The VIX is still above 22, which is statistically a short-term negative for equity markets.

The silver lining is that we could see another push higher for equity markets before year-end, but any rally will be shorter lived than its predecessors. Following a final push, equity markets will succumb to ever-increasing headwinds and significantly lower earnings growth next year. We are approaching a seasonally strong period for financial markets; going back to 1930, the average November-December price change for the S&P 500 in midterm election years is 3.5% (according to Bloomberg data). We also note that the buyback blackout period is ending, and global growth, while decelerating, is not actually contracting. Global equities are pricing in the worst-case economic outcome heading into a seasonally strong period, which could lead to some positivity into the end of the year.

Fast forward into 2019, though, and US equities look dangerous. We will have slowing repatriation of funds and fewer buybacks (which have artificially suppressed US equity volatility and buoyed the stock market), peak profit margins as the fiscal stimulus fades, and rising input costs rising due to energy, wages, and tariffs. 2019 has the potential to be a tumultuous year for all asset classes with maximum Fed tightening, draining dollar liquidity, and rising interest rates. Volatility will likely increase in intensity as the Fed moves further into a financially restrictive phase throughout 2019.