Markets are anxious… What should the investors do?

Ela Karahasanoğlu

-The Israel-Palestine war that erupted unexpectedly sent shockwaves throughout the globe. As always investors reacted by selling stocks, seeking safer assets, and flocking to the US dollar. Long before the crisis unfolded in Middle East, markets were already jittery in part due to stubborn inflation and better than expected economic data. The data that came out in October added to the markets’ concern that the US Federal Reserve would remain hawkish longer than anticipated.

–The impact of increased geopolitical risks and risk of persistent inflation continued to contribute to concerns of a recession as opposed to a soft landing. This weighed on equities in October. As of October 31^st, the US equity index S&P 500 and European stock index Euro Stoxx 50 were down by -2.2% and -2.7% for the month, dragging their year to date returns to 9.2% and 7.1% respectively.

–During times of heightened geopolitical tensions, gold tends to rally as it is seen as a safe haven investment. Investors turn to gold as a store of value and a hedge against uncertainty. Case in point price of gold surged in response to the Hamas kidnappings and Israel’s reaction. As of October 31st, the first month futures contract for Gold was up by 6.9% on the month jacking up its year-to-date return to 9.2%.

–As of October 31^st, Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds, dropped slightly by -0.7% on the month. Similarly, Bloomberg Global Corporate Bond and High Yield Bond Indexes were also down on the month losing -1% and -0.9% respectively. This brought their year to date returns to 0.4% and 4.6% respectively.

–Concerned by geopolitical risks, investors also took shelter in crypto assets given their diversification benefits particularly against traditional asset classes. This triggered an outsized spike in crypto currencies with Bitcoin up by 28% and Ethereum 8% in October. This reversed most of the losses from earlier in the year bringing Bitcoin’s return to a whopping 109% and that of Ethereum to 51.3% on the year.

–Turkish stock market reversed course in October and dropped both in local as well as in US dollar terms. In October Turkish stocks lost -9.8% in local currency terms (-12.6% in US dollar basis). This brought the index’s year to date return to 36.4% in local terms and -9.8% in US dollar basis. As we are approaching the end of the year, investors should be rather cautious.

–Investors should carefully assess their risk exposure and consider diversification strategies to protect their portfolios. Maintaining a balanced allocation across different asset classes and regions, including alternatives such as currencies, commodities, inflation linked strategies, crypto and less liquid private market investments can help mitigate potential downside risks.

2023 is definitely shaping up to be as eventful a year as 2022, particularly on the geopolitical front. The world woke up to some shocking news on October 7 – not only Hamas, an Islamist militant movement and one of the Palestinian territories’ two major political parties, had kidnapped thousands of people of different ages, citizenship and backgrounds in an organized fashion, they also had killed many others. They demanded Israel to pay attention to their demands… and that is exactly what they got! Before October was over, Israel had already completed multiple deadly attacks on the Gaza strip killing thousands of people and injuring at least as many. It is still not clear whether this will lead to the release of any of those kidnapped or held hostage by either side. However, there doesn’t seem to be an end in sight to these deadly attacks.

While the markets are not new to wars or geopolitical tensions, this unexpected set of events sent shockwaves throughout the globe. This was because it wasn’t just Israel but also more than 30 other countries who had their citizens among the kidnapped or killed, complicating the matters further. It also injected quite a large dose of uncertainty into the markets. Investors reacted by selling stocks, seeking safer assets, and flocking to the US dollar.

As we had discussed in our previous issue, long before the crisis unfolded in Middle East, markets were already jittery in part due to stubborn inflation and better than expected economic data. While strong macroeconomic data is positive for the markets in general, those that came out in October added to the markets’ concern that the US Federal Reserve (FED) would remain hawkish longer than anticipated.

So how did the global markets respond to all of this?

The impact of increased geopolitical risks and risk of persistent inflation continued to contribute to concerns of a recession as opposed to a soft landing. This weighed on equities in October. As of October 31^st, the US equity index S&P 500 and European stock index Euro Stoxx 50 were down by -2.2% and -2.7% for the month, dragging their year to date returns to 9.2% and 7.1% respectively.

The global equity markets suffered from the negative sentiment as well. As of October 31^st the global equity indicator MSCI All Country World Index (ACWI) and the emerging market index MSCI EEM were both down by -2.5% and -3.3% on the month respectively. While ACWI managed to hang on to its positive return on the year with 6.1%, losses in October moved EEM into the negative territory with -3.2% return year to date.

GOLD RALLIED DUE TO GEOPOLITICAL RISKS

During times of heightened geopolitical tensions, gold tends to rally as it is seen as a safe haven investment. Investors turn to gold as a store of value and a hedge against uncertainty. Case in point price of gold surged in response to the Hamas kidnappings and Israel’s reaction. As of October 31st, the first month futures contract for Gold was up by 6.9% on the month jacking up its year-to-date return to 9.2%.

CRUDE OIL REVERSED ITS GAINS FROM SEPTEMBER

Crude oil had a mixed month, eventually dropping towards the end of the month. The reason was the conflict in the Middle East, which is a major oil-producing area. Any conflict or geopolitical instability that has the potential to disrupt global oil supplies tend to put upward pressure on crude oil prices. This is also what happened in October. However, the concerns about a potential recession due to high interest rates dampened expectations for future oil demand. Consequently, crude oil prices dropped. As at end of October the first month futures contract for US crude oil WTI was down by -10.8% on the month, reversing almost its entire gain of 12% in September and dragging its year-to-date return to only 0.9% in line with the souring market sentiment.

BOND YIELDS REMAINED HIGH DUE TO PERSISTENT INFLATION

It was also a bit complicated in the land of rates and bonds in October. Normally when there is a risk-off sentiment in the markets, investors tend to shift their investments to safer assets such as government bonds. This increases demand for bonds, driving down their yields and thus increasing their prices. However, in October it was the opposite. Why? It was all because of “higher rates for longer” theme due to stronger than expected economic growth and higher than expected inflation. The US Treasury bond yields continued to climb and therefore their price dropped, although to a limited degree as investors flocked to safe assets such as US Treasury bonds due to geopolitical risks.

As of October 31^st Bloomberg Global Aggregate Bond Index, the benchmark for global investment grade bonds, dropped slightly by -0.7% on the month. Similarly, Bloomberg Global Corporate Bond and High Yield Bond Indexes were also down on the month losing -1% and -0.9% respectively. This brought their year to date returns to 0.4% and 4.6% respectively.

CRYPTO MARKETS BENEFITTED FROM NEGATIVE SENTIMENT

Concerned by geopolitical risks, investors also took shelter in crypto assets given their diversification benefits particularly against traditional asset classes. This triggered an outsized spike in crypto currencies with Bitcoin up by 28% and Ethereum 8% in October. This reversed most of the losses from earlier in the year bringing Bitcoin’s return to a whopping 109% and that of Ethereum to 51.3% on the year.

TURKISH STOCKS DISAPPOINTED ITS INVESTORS

Turkish stock market reversed course in October and dropped both in local as well as in US dollar terms. In October Turkish stocks lost -9.8% in local currency terms (-12.6% in US dollar basis). This brought the index’s year to date return to 36.4% in local terms and -9.8% in US dollar basis. The reason for the monthly performance in US dollar being lower than the one in local terms was due to 3.2% appreciation in greenback against Turkish Lira.

MARKET VOLATILITY COULD SPIKE TOWARDS THE END OF THE YEAR

As we are approaching the end of the year, investors should be rather cautious as markets tend to get more whipsawed during the holidays season. This is because market players unwind their positions as they head out for the holidays. Reduced liquidity periods create the perfect storm for wild market moves.

In addition to these regular year-end market dynamics, this year there are couple other factors that might impact markets adversely. Should inflation persist, continued strength in US and global economic data may impact timing and pace of not only FED’s but also other major central banks’ approach to setting interest rates. Any surprises or deviations from market expectations in these policy decisions could lead to increased volatility. Let’s also not forget the non-economic factors such as the ongoing geopolitical tensions and potential COVID-19 variants.

INVESTORS SHOULD REVIEW THEIR PORTFOLIOS REGULARLY

As reiterated in our previous issues, investors should carefully assess their risk exposure and consider diversification strategies to protect their portfolios. Maintaining a balanced allocation across different asset classes and regions, including alternatives such as currencies, commodities, inflation linked strategies, crypto and less liquid private market investments can help mitigate potential downside risks. It is essential to remain adaptable and adjust investment strategies based on changing market conditions. Regular portfolio reviews and rebalancing can go a long way in helping optimize not just returns but also the risk-adjusted returns.

ELA KARAHASANOGLU, MBA, CFA, CAIA

International Finance Expert

karahasanoglu@turcomoney.com

ela.karahasanoglu@ekrportfolioadvisory.com

https://www.linkedin.com/in/elakarahasanoglu/