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Volatility returns to markets

3/3/2018

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What’s caused the recent market correction?
Equity markets have been going up steadily and consistently for quite some time. For example the S&P500 has risen each month since 0ct 2016.
 
It is historically unheard of to avoid ‘down months’ for 15 months in succession.  Additionally, market volatility has been very low.  Against this backdrop of serene market ascendancy, we have experienced a short modest correction and spike in volatility.
 
The trigger initially seemed to have been the US Department of Labour Wage data, released in February.
 
So, what is really going on?
The economic data in the USA and the rest of the World has been very strong of late, something which we as advisers have been keeping a close eye on. Global economic growth is accelerating and this is leading to bond yields rising, not just in the States, but places like Germany as well. This is one of the factors behind our cautious stance on bonds as an asset class.
 
Rising bond yields can be a good thing as they are a sign of a return to more normal economic conditions. Rather than a monetary policy mistake (fear of rising inflation), higher yields across the globe reflect increasing comfort with the growth and inflation outlook.
 
Despite the recent move up, bond yields remain low both by historical standards and where you would expect them to be given where economic growth and inflation currently stand. Central Banks also remain conscious of the need to gradually tighten interest rate polices, rather than spring any nasty surprises.
 
What does this all mean?
We’ve had a sharp sell-off in equities recently, but in reality nothing has fundamentally changed in the real economy. The economic data out of the USA continues to be very strong, as is the data from Europe, Japan and China.
 
Normally when equity markets sell off, the more defensive and reliable shares hold up the best and the most economically sensitive stocks do the worst. But this correction has been more random – Miners have held up well, but Utilities have been very weak.
 
So there seems to be no real underlying message in terms of which shares are leading the fall. That is important as it suggests no underlying genuine market concerns about the economy. This feels like a stock market correction rather than something more fundamental.
 
After a period of unprecedented tranquillity in equity markets (bonds have, by contrast been far from calm), we are now looking at more normal levels of volatility and portfolios should be constructed and positioned taking this into account.
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    Director, David Hardman has over 20 years experience in financial services.

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