Market risks to monitor

Summertime and the living is easy? Not quite when there’s a pandemic and reactive markets to contend with. Recent market commentary outlined the risks that lie in wait for investors during these hazy weeks of summer.

Kristina Hooper, chief global market strategist with Invesco, wrote in a blog post this week that she was closely watching for headwinds that could trigger the next selloff.

Covid-19 topped the list, with the Delta variant responsible for continued spread globally, including in Southeast Asian countries such as Indonesia.

“Given double-digit positivity rates, medical experts are worried that Indonesia could be an ideal breeding ground for more variants of Covid-19,” Hooper wrote.

She also noted the potential for vaccine effectiveness to wane, as data from Israel may suggest, and the subsequent effect for investors. “If vaccines were to no longer be very effective in the face of Covid, that could cause a serious case of market nervousness,” Hooper said.

In a midyear outlook report, Mackenzie Investments also noted the risk that Covid-19 variants pose, including breakthrough infections — though it said it viewed breakthrough variants more as a tail risk, likely to “spur renewed vaccination efforts, along with a repeat of government supports.”

The flip side, as economies reopen, is contending with less government support. On Wednesday, the U.S. Federal Reserve stopped short of tapering, but stated that the economy was closer to reaching the Fed’s employment and inflation goals. As the Fed moves toward normalization of its monetary policy, ongoing commentary from Fed committee members this summer can rattle markets, Hooper said.

While less government support is a potential hurdle for risk assets, businesses also face supply chain issues and labour shortages, the Mackenzie report said. If these persist, the market would need to price in adverse outcomes, such as margin pressure due to rising costs.

While businesses generally benefit from increased demand and can address supply constraints given time, they’ll be challenged if central banks raise rates abruptly in response to rising inflation, Mackenzie said.

The U.S. debt ceiling is another market headwind, with the debt limit suspension expiring on July 31. The ceiling affects the U.S. Treasury’s ability to issue bonds and pay its bills, Hooper said.

While the U.S. government can probably continue to function using “extraordinary measures” until the fall, “the longer it takes to reach a deal [on raising the ceiling], the greater the potential for volatility,” she said.

Hooper suggested investors be prepared for selloffs by staying diversified and liquid: “For those with cash on the sidelines, keep looking for buying opportunities.”

While Mackenzie said it expects the recovery to continue, “markets are long overdue for a normal, healthy correction” of about 10%.

“Should that scenario unfold, we would be buyers of risk assets,” the firm said.