Equity Markets Keep Falling

The equity market volatility from last week continued into this week.

The Dow Jones has experienced its worst week in two years. US equity markets reached “correction” territory (a decline of 10% from the peaks in January).

Concerns over higher longer term interest rates and a more aggressive Federal Reserve Fed Funds Rate tightening path than expected are the backdrop to the recent downturn in markets.

It also appears that the short VIX (volatility) products significantly added to market volatility. A good explanation of how these inverse volatility products impacted on market volatility can be found at $XIV Volpocalypse – A Sea of Disinformation and Misunderstanding

The US inflation number on February 14th has taken on heightened importance and will be the focus of markets this week i.e. a likely source of volatility

What has changed? Not much.

As expected prior to the “market melt-down” volatility was expected to pick up from historical lows and that interest rates would rise over coming months. Albeit the volatility has occurred more abruptly and violently than anticipated (as it often does).

US longer dated interest rates have reached 4 year highs but remain near historically low levels.

The global economy is characterised by synchronised economic growth. It is expected that all 45 of the larger economies monitored by the OECD will experience growth in 2017 and 2018. It has been a while since this has occurred. In the US unemployment remains at near historical lows and financial conditions remain supportive of ongoing economic activity. US equity markets are still up over 10% for the last 12 months.

It is a good idea to go back to what was being said prior to a large market event.

The comments by Mohamed El-Erain, the chief economic advisor at Allianz, at the Inside ETFs conference 23 January 2018 are a good reference point for the current market situation.

El-Erain told the conference we are not in an asset bubble but that we should expect a higher level of market volatility in 2018. Mohamed El-Erain: We’re Not in a Bubble

His comments focussed on the fact that the US Federal Reserve (Fed) would continue to normalise monetary Policy in 2018 e.g. lift interest rates over the year to more normal levels while also reducing the size of the Fed’s Balance Sheet.

El-Erain noted 3 key risks for 2018:

  1. Geopolitics e.g. Korea and the Middle East
  2. What happens if the four major Central Banks try to normalise monetary at the same time i.e. Fed, China, Japan, and Europe
  3. A market accident e.g. a liquidity event in say an ETF given an over promise to deliver

The last risk is very insightful given the events of the inverse volatility products over the last 10 days. I am quite sure El-Erain did not expect that risk to materialise so quickly!

 

So if things change, you change your mind, to badly paraphrase Keynes. Not sure that things have changed that much but maybe a realisation interest rates are actually heading higher and the very low level of market volatility experienced cannot last for ever. The US equity market is still trading on high valuations.

Whatever you do don’t panic. The Topic of my next post.

 

Please see my Disclosure Statement

 

3 thoughts on “Equity Markets Keep Falling

  1. Pingback: Investment Mistakes to avoid | Kiwi Investor Blog

  2. Pingback: Are we in a Bubble? | Kiwi Investor Blog

  3. Pingback: US Equity Market 9 Years of Advancement | Kiwi Investor Blog

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