3 Potential Market Disruptors No One is Talking About, Yet

    Facebook Twitter LinkedIn Email

By Cleo Chang - First Quarter 2020

There are a lot of obvious factors that could affect investor sentiment in 2020—Brexit, trade wars, elections, you name it. However, I’m monitoring three issues that not everyone is talking about: liquidity, equity market volatility, and credit market spreads.

Liquidity Smoke Signals

We heard a lot of talk about repo and reverse repo markets in 2019. The repo rate spiked multiple times, and the Federal Reserve had to intervene. While this happens occasionally, it's still an anomaly. And there were a lot of anomalies in 2019.

Repo markets are a very important component of capital markets. They provide a significant portion of the short-term liquidity markets need to conduct business. On average, there are more than $3 trillion in daily exchanges in the market for repos.

We're not alarmed, but we are paying attention to how often and to the degree the anomalies are happening. If they continue through 2020, we may have to reassess our holdings.

Bumpy Markets Ahead?

While I don't think we're in bubble territory, we are definitely seeing stretched valuations in certain parts of the equity market. The question remains—are those stocks worth the elevated price? It depends on how you determine value.

Personally, I look for year-over-year earnings improvements. Earnings growth is a type of fundamental improvement that indicates a company is growing. When we look at trailing earnings from the S&P 500 index, there was a 3-4% improvement in 2019 over 2018. Yet, the S&P 500 index returned over 20% in the same period. Where did all that additional return come from? Primarily from the price-to-earnings (P/E) multiple expansion.

Historically, investors have been comfortable with P/E multiples in the mid-to-high teens. This means they've been okay with stock prices 15-19 times higher than a company's earnings per share. But now we have gone past the high teens.

It's not unprecedented; the markets have certainly been in a higher range before. However, I think we will continue to push ourselves out of that comfort zone in the year ahead. Therefore, I'm not sure this type of valuation improvement is as sustainable as something more fundamental.

Interest Rates are Spread Thin

Finally, we're keeping an eye on credit markets. Fixed income investors sought higher quality in 2019. As a result, the difference (or spread) in price that investors were willing to pay versus the prices sellers were willing to accept for the bonds became very narrow or tight.

We carefully monitor movements within different credit sectors, with particular attention on bank loans. If we see liquidity freeze up in that sector, it may be a telltale sign of worse things to come for the credit market as a whole.

    Facebook Twitter LinkedIn Email
Cleo Chang
Cleo Chang
Head of Investment Solutions

Our 2020 Vision

Get additional insights from our CIOs in the latest Investment Outlook.

Discover More
  • Related Articles
  • More From Author

Global Governments Unleash Viral Response to World’s Economic Ills

COVID-19 continues to spread, and countries are ramping up their responses to protect vulnerable economies. Will their efforts pay off?

Panic And Perspective

Markets may have panicked today, but we think it’s best if investors respond with poise and patience instead.

Fed Prescribes Rate Cut for Virus-Related Economic Ills

The Federal Reserve surprised markets with an emergency 0.50% rate cut on March 3. Our investment managers explore the move and potential market responses.

    Fed Prescribes Rate Cut for Virus-Related Economic Ills

    The Federal Reserve surprised markets with an emergency 0.50% rate cut on March 3. Our investment managers explore the move and potential market responses.

    3 Potential Market Disruptors No One is Talking About, Yet

    Liquidity, volatility and credit spreads may all have a role to play in the year ahead, according to Head of Investment Solutions Cleo Chang.

    Central Banks vs. Equity Markets: Is the Tail Wagging the Dog?

    Deep-rooted relationships in global capital markets may affect how investors evaluate risk-adjusted returns.

      The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.

      American Century Investments is not responsible for and does not endorse any comments, content, advertising, products, advice, opinions, recommendations or other materials on or available directly or via hyperlinks from Facebook, Twitter or any third-party website. Facebook, Twitter and LinkedIn are registered trademarks of their respective owners.