Volatility Continues

After years of steady, undramatic growth in equity indices volatility returned with a bang in 2018 with a February “flash-crash” which at one point saw the Dow Jones drop 1,600 points before rallying 750 into the close. Following the shock of February, the markets attempted a recovery before re-testing the previous year-to-date lows but since Easter we have again seen a steady appreciation in equity indices back to near-record levels.

This has led to renewed speculation of when the next reversal is going to happen. Market participants from Morgan Stanley and Fidelity have suggested that markets are trading at their peaks and even legendary market veteran, Art Cashin of UBS has drawn parallels with recent volatility to that of the infamous 1987 Black Monday period.

There are several geopolitical and technical headwinds which are driving this sentiment. We are approaching the 10-year anniversary of the Lehman Brothers bankruptcy and the central bank coordinated low interest rate policies are ending. The Federal Reserve has increased rates several times (the latest coming last night) amid increasingly hawkish sentiment. The European Central Bank has just announced they will be ending their Quantitative Easing (QE) program in December and the Bank of England raised interest rates for the first time in 10 years in November (although a number of expected 2018 rate rises have been postponed due to weak economic data). The underlying concern for equity holders is whether there will be a large scale repeat of the “Taper Tantrum” of 2013 when adjustments to the Federal Reserve’s QE program caused the bond yields to spike and equity markets crash. Central bankers are being understandably cautious in their policymaking but the worry for equity holders is when the big-reversal will start.

Additionally, the new and evolving market trading structure featuring high-frequency-trading, multi-lateral-trading facilities (MTFs), dark pools and algorithmic execution systems has tended to exaggerate volatility in the markets, as evidenced by the February flash-crash and its forerunner in 2010. Indeed the 2010 flash crash was narrated live by CNBC with pictures of protestors on the streets of Athens as a reflection of the Euro-crisis at the time. Compared to then we have similar number of geo-political headwinds causing concern for investors. Notwithstanding the smiling photo-calls in Singapore between Trump and Kim Jong Un there is much work to do before meaningful progress on the North Korea issue. Trump’s “America-First” trade and tariff policy is already affecting global market confidence, usually based on the tone taken in his latest tweet. Earlier this year, longstanding CNBC contributor, Larry Kudlow encouraged the President not to escalate the “trade war” but he is now Director of the United States National Economic Council and accompanying the President at to G7 meetings. In addition, political tensions with Iran and Russia show little sign of thawing, oil prices continue to rise, the Italian elections have threatened Eurozone stability and Brexit uncertainty continues. Even the U.S large-cap technology industry has come under pressure with investigations into Facebook affecting the whole FAANG sector (that’s Facebook, Amazon, Apple, Netflix and Google).

When the next downturn arrives, the concern is that capitulation from both relatively inexperienced investors and hedge funds using sophisticated high-frequency trading models could lead to exaggerated volatility – the sort that keeps everyday investors awake at night. Frustrated savers who have migrated into equity income funds in search of yield over the last few years should be aware of these risks.

Provided for informational purposes only. Not designed as advice. Speak to your IFA or tax advisor for advice tailored to your individual circumstances.