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Near-term market sentiment: Nervous, but still difficult to see where a trigger for a bear market might come from. After a run of ten consecutive days of new highs, the MSCI World index of global stock markets began retreating last week and has now seen five consecutive daily falls. The FTSE 100 is at a five week low. Other risk assets have also seen declines, with U.S high yield down 1.1% so far this month. The flattening of the U.S Treasury yield curve, so much a story of 2017, has faltered as investors dial down their forecasts for upcoming Fed rate hikes. Why? Lots of individual themes can be put together to form an explanation. These have included a renewed fear of a slowdown in China (which has hit commodity stocks in particular), to scepticism over the likely success of U.S tax reform, and fear of Lebanon becoming a new proxy battlefield for Saudi Arabia and Iran to fight in. But at its heart the downturn represents animal spirits, investors nervous of lofty valuations are taking profit and using geopolitical headlines to justify doing so. And why not? The combination this year of steady gains on global stock markets with very low volatility has produced good results for investors in absolute, and on a risk-adjusted basis. The MSCI World index remains 17% up in USD terms, 14% in local currency terms.

Outlook: As we have long argued, in the absence of a recession or a sharp rise in U.S and global interest rates, it is difficult to see what might cause a full-blown bear market for risk assets. A recession appears unlikely -at least in the near term – given the recent upgrades to world GDP growth by major financial institutions, and notably the IMF. The increase seen in global corporate earnings in third quarter results appears sustainable. Inflation remains tame, with the Fed the only major central bank raising interest rates at present at present. However, its monetary policy tightening – which includes the unwinding of its quantitative easing program- is likely to continue to be done at a cautious pace when Jerome Powell takes over from Janet Yellen, as chair, in February.

However: While a bear market appears unlikely, a correction – often defined as a fall of around 10% – may well happen as profit taking triggers a more broad sell-off, particularly by leveraged investors. But low risk-free rates (eg, bank account cash rates and core government bond yields) will limit the extent of the sell off, particularly given the positive news flow concerning global GDP growth and corporate earnings

Until then, those who have sold in recent days face a dilemma: Do they remain in cash, or shelter in short-duration bonds and other defensive assets that will produce a negative real yield until a correction takes place? What if a correction ends after a 5% fall – do they buy, or wait until a further fall? How long can they remain out of the market? Such are the poker-like perils of market timing. All of which points to the advantages of remaining fully invested in a multi-asset portfolio, which will offer protection should stock markets fall and relatively safe government bonds rally in response.

Sterling: the U.K currency continues to be a plaything of Brexit. The more markets sense that leading Brexitiers in the U.K government don’t actually want a deal with the E.U, the weaker the currency will become. It may be supported by higher Bank of England interest rates, but only if inflation continues to rise much above the 3% level recorded for both October and September.

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