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Your Thoughts: Increased Volatility Ahead?

Posted: 13th February 2018 by
Finance Monthly
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Despite a swift comeback from the global stocks chaos last week markets have been shaken up.

Dow Jones closed at 24,601 yesterday, up from the 23,860 low of last Thursday. The plunge happened on the 1st of the month, across the weekend, recovered, and dropped further. Dow Jones is now on a recuperating trajectory. The same drop, recovery and further fall also happened within the same time frame for the S&P 500, NASDAQ and the FTSE 100.

All are on their way back up but fears of increased volatility are floating around. Finance Monthly has collated a number of comments and market responses from experts and economists worldwide in this week’s Your Thoughts.

Phil McHugh, Senior Market Analyst, Currencies Direct:

The switch to risk off in the markets was markedly sharp and severe against an air of positive momentum which ran ahead of the fundamentals. The S&P index fell by more than 4% which was the steepest single day drop since August 2011. The rout continued into Asia markets and the spark was growing concerns that inflation will force borrowing costs higher.

The momentum since the start of the year has been bullish with equities pushing higher and the USD selling off. The honeymoon period for equities has now hit a question mark over potential rising borrowing costs. It can be argued that the bull run had ran somewhat ahead of sentiment with overconfidence creeping in. The higher wage inflation from US payroll data on Friday was the beginning of the doubts and this was enough to encourage some profit taking that has now spilled into a wider sell off.

We have not seen a big correction since Brexit and although we could see further selling pressure it should find support soon on the underlying improved global economic optimism and growth.

In the currency markets the reaction was more balanced but we have seen a defined swing into the classic risk off currencies with the Japanese Yen and Greenback gaining ground.

The pound lost ground after a strong start to the year. The pound tends to suffer in a risk off market and the weaker services data yesterday and concerns over the latest Brexit talks have helped it on its way lower. The next focus for the pound will be the Bank of England meeting on Thursday.

Lee Wild, Head of Equity Strategy, interactive investor:

Just as markets cannot keep rising forever, they must also stop falling at some point, but it’s still unclear whether we’ve reached a level where buyers see value again.

Futures prices had indicated a much brighter start for global markets, but early gains were wiped out in Asia and Europe looks vulnerable. Volatility is back, and investors had better get used to it.

While there’s certainly a case to be made against high valuations, especially in the US, there are lots of decent cheap stocks around. Plenty of investors are itching to bet that concerns about inflation and bond yields are overdone and that any increase in either will be much slower than expected. If that’s the case, a 10% correction in the US looks more like a healthy retracement rather than reason to hit the panic button. Long term investors will be amused by it all and are either choosing to ignore the noise or pick up stock at prices not seen for two months in the US and over a year in London.

There are stark similarities between this sell-off and crashes both in August 2015 and in early 2016 when market volatility reached similarly extreme levels. It took several trading sessions played out over weeks to find a bottom, and it’s likely the same will happen here. Only difference this time is that it’s the tune of US economic data, not China’s currency devaluation that markets are dancing to.

Kasim Zafar, Portfolio Manager, EQ Investors:

Pullbacks in markets are (usually) quite normal and healthy, giving moments of pause where everyone pats themselves over, does a quick sense check and then carries on. In the case of the US equity market it hadn’t fallen more than 5% in 404 trading days (back to June 2016). That’s the longest stretch of ‘uninterrupted’ gains in history, with data back to 1928!

There weren’t enough signs of investor heebie-jeebies around, especially not in January when the US index was up over 7% for the month at one point. That’s pretty extreme and entirely unsustainable.

The equity market has finally taken notice that over the last several weeks bond markets have been reflecting a higher inflation and interest rate environment, so it’s not at all surprising to see some adjustment and a return of some much needed investor fear!

We are going through the quarterly reporting season for US companies currently, which is a good test of what’s happening on the ground. With 264 out of 500 US companies having reported so far, most are reporting positive results for both top line revenue growth and bottom line earnings.

So, as things stand, we see this as a long overdue market correction and if it falls much further we would be looking to increase our equity weightings. Increased volatility is a healthy sign of investors becoming more conscious of the risks inherent in markets.

Ray Downer, Trader, Learn to Trade:

Though you may not knowingly own any shares, there is a high chance that you are paying into a pension scheme which invests in shares and bonds. This means the value of your pension pots is dependent on the value of the investments in it and while investment values increase and decrease all the time and this will have very little noticeable difference to your savings, financially turbulent times like this will impact you in some way, particularly if you’re looking to retire this year.

For now, at Learn to Trade we are looking at this in the context of a correction rather than a reversal. Following this week’s FTSE 100 fall, investors should keep a close eye on the stock markets in the months ahead as the value of the pound has gotten weaker with the sell-off. The Bank of England will announce whether or not it plans to raise interest rates because of this ‘bloodbath’ later this week when it publishes its quarterly inflation report. Should the Bank of England announce a rise in inflation rates, British consumers will have less spending power and will start to feel the pinch of higher costs on imported necessities. The inflation report will give us a clearer picture of how this will impact our everyday spending.

Bodhi Ganguli, Lead Economist, Dun & Bradstreet:

It’s a common misconception that stock market activity is linked to the economy. However, an unexpected and ferocious swing in the stock market is disruptive and can wipe out a significant chunk of wealth from the markets – resulting in economic implications. This week’s activity could mean retail investors could see a significant erosion in their nest egg, which would be bad for future consumer spending.

The latest crash was caused by technical or algorithmic trading, most likely computer-generated as at times the stock market was dropping faster than that can be explained by human intervention. These changes were exacerbated by macro-economic triggers such as the recent US jobs report, which was a strong signal of wage inflation returning. This caused market participants to upgrade their inflation outlook with more Feb rate hikes expected. Bond yields also crept up, setting off a bearish shift in the stock market.

We expect the stock market to stabilise in the near future, but the longer term outlook will be determined by how these fundamental macro-economic triggers interact with each other going forward.

Ken Wong, Client Portfolio Manager, Eastspring Investments:

Currently, the market is going through a much-needed correction as valuations were approaching expensive levels for most markets. In particular, China’s equity markets were up 70% over the past 13 months, and this recent 10% correction from its high is actually not that steep.

Despite the recent market correction, investors in Asian equity markets still seem to be in a better position at a time when corporate America seems more hard pressed to deliver elevated profit expectations while also trading at very expensive valuations. Asian equity markets are trading at a P/B ratio of around 1.7x while US equity markets are still trading at 3.2x P/B after this recent price correction.

Asian corporates in general are still expected to deliver strong corporate earnings and most are in good shape as a result of previous cost cutting and balance sheet restructuring that we have seen over the past few years. Despite the recent market volatility, things are still quite sound in this part of the world, Asian corporates are still expecting to see their earnings grow by around 13% in 2018, with China leading the way with earnings growth expectations of over 20% this year.

For investors concerned about the recent market volatility, they should look at investing in a low volatility equity strategy as we have seen these types of strategies outperform the broader benchmark indices by over 2% over the past few days. The benefits of these low volatility equity strategies is the fact that they have bond like risk / volatility characteristics while providing investors with an enhanced dividend yield and market returns which are more in-line with equity returns.

As long as there is still enough cheap liquidity out in the market place, we could start to see some bottom fishing over the coming days as investors start to look for cheap / undervalued stocks. In particular, investors could look toward those sectors that underperformed in 2017, such as financials, energy and consumer staples.

Richard Perry, Market Analyst, Hantec Markets:

Equity markets remain highly attuned to the threat of the increase in volatility across financial markets at the moment. Equities are considered to be a relatively higher risk asset class, so with a huge sell-off on bond markets, equity markets have also come under threat. The concern comes in the wake of the jump in US earnings growth to 2.9%, a level not seen since 2009. A leap in earnings growth has investors spooked that this will lead to a jump in inflation which could force the Federal Reserve to accelerate its tightening cycle. Markets can cope with gradual inflation but inflation running out of control can lead to significant volatility, such as what we have seen recently. The high and stretched valuation of equities markets meant that was the prime excuse to take profits.

For months, analysts have been talking about the potential for a 10% correction and at its recent nadir, the S&P 500 had corrected 9.7%. So is this just another chance to buy, or the beginning of a bigger correction? The key will be the next series of inflation numbers, with CPI on the 14th February and core PCE at the end of the month. If inflation starts to increase appreciably, longer dated bond yields could take another sharp leg higher, perhaps with the 10 year breaking through 3.0%. Subsequently, equities would come under sustained selling pressure with volatility spiking higher once more. However, if there can be a degree of stabilisation in the bond markets, then equity investors can begin to look past immediate inflation fears and then focus back on the positives of economic growth in the US, Eurozone and China.

Alistair Ryan, Senior Dealer, Frontierpay:

This afternoon’s hawkish approach from the Bank of England came as a surprise; I personally – along with many others – didn’t expect there to be any talk of a rate rise in the UK until at least the end of 2018. The services sector, which makes up around 80% of UK GDP, faltered this month and wage growth is slowly increasing but remains low at 2.4%. Both of these factors suggest a slack economy, so I expect we will see many questioning whether this is the right time for a rate rise.

If we were to see some further improvement in the economy over the coming months, then a rate rise would of course be a possibility, but whilst wage growth and inflation slowly start to correlate, I don’t think we will see any movement on the base rate.

We would also love to hear more of Your Thoughts on this, so feel free to comment below and tell us what you think!

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