Tuesday 11 December 2018

Market jitters persist in spite of week-ending rally

Return of volatility sees nervousness spread as investor community reacts

Traders monitoring financial data inside the Frankfurt Stock Exchange last week, as the equity rot continued to spread around global markets
Traders monitoring financial data inside the Frankfurt Stock Exchange last week, as the equity rot continued to spread around global markets
Gavin McLoughlin

Gavin McLoughlin

Last year was an excellent one to be an equity investor, as markets hit record highs and volatility hardly featured.

That was never going to last, but the nature of the sell-off witnessed in recent days has rattled plenty of market participants nevertheless.

Most people believe the downward movement was caused by strong wage data out of the United States, which sparked fears of an uplift in inflation and faster-than-expected interest rate hikes.

The question now is whether the downward trend of last week will be a short-lived correction or a full-blown crash. The S&P 500 lost 5.2pc last week - its worst weekly run in over two years.

Goodbody Stockbrokers' chief investment officer, Bernard Swords, took to social media network LinkedIn on Thursday, saying he believed the market moves were "driven more by fear than fact".

Swords wrote: "The facts are that the global economy is accelerating, while structural forces continue to limit the inflationary impact of the growth, which keeps us in a Goldilocks environment.

"There is, to date, little evidence of the build-up in inflationary pressure. Yes, the most recent non-farm [US] payrolls report showed average earnings hit a year-on-year growth rate of 2.9pc, but we have been here before only to see the growth rate drop back to 2.5pc... outside of wages, we are still seeing downward pressure on inflation."

At home, the Iseq index of Irish shares lost 4.15pc on the week - the worst performance since February 2016. Darren McKinley, senior Irish equity analyst at Merrion Capital, believes buying opportunities are coming for Irish investors, but is cautious for now.

"I wouldn't be in favour of putting much money to work at the moment until we start to see some stability. My main concern would be keeping an eye on the European bond market now given that yields are significantly lower than in the US," McKinley told the Sunday Independent.

"Over the last week what we've seen is [Angela] Merkel's party has gone into coalition with the SPD and the finance ministry has been handed over to the SPD. They're very much in favour of fiscal expansion, so all of a sudden the Germans are going to start spending their surplus.

"I would suspect that the German yields could continue to move out and that could weigh on markets in the short term."

McKinley mentions the old saying that when the US sneezes, the rest of the world catches a cold. On that basis, market observers may have taken some solace from the end result of Friday's trading session, when stocks finished in the black on the day after a strong late rally.

But it was another session marked by substantial volatility - and that's the kind of thing that makes investors nervous.

The S&P 500 index closed 1.5pc higher on the day. But the sell-off has wiped out the benchmark's gains for the year, and there are fears rising Treasury yields could spark more convulsions. If inflation grows, you would tend to expect investors to seek higher yields to safeguard real returns, lifting borrowing costs.

"Sometimes making a bottom can take time," said Ernie Cecilia, the chief investment officer at Bryn Mawr Trust Company. "Investors should be at least aware, cognisant, and expect a little more volatility after we go through this period."

However, economic fundamentals are strong, according to Peter Brown, founder and senior investment adviser at Baggot Investment Partners.

"We're not going to get a crash here followed by a recession," Brown told the Sunday Independent. "We probably will get a correction - if not this time, it will be some time this year.

"What we're seeing here is what's called a deleveraging. And a deleveraging is just an unwinding of positions. The market, which has rallied since 2010, has had a little bit of irrational exuberance in the month of January."

Inflation is the key, says Brown, because there is a large amount of debt in the market, particularly in large-cap stocks.

"Big cap stocks borrowed $3.5 trillion of quantitative easing-type money and they used that to buy their own stock. The market is extraordinarily sensitive to the potential of an upward movement in interest rates.

"However, the mid-cap stocks didn't get offered any of the quantitative easing money, so they're in a very good position. They're well structured in terms of their balance sheet, not as much debt.

"The underlying global economy looks very strong - but interest rates are just wrong and that's what's causing the scary part."

Everything we've seen in the last couple of weeks has been driven by the equity markets, according to Garret Grogan, who is the head of global trading at Bank of Ireland global markets. Interest rate moves may have started the sell-off, he says, but it's the increase in volatility that has added fuel to the fire.

"While some technical indicators or valuations may have seemed stretched, and left the market vulnerable to a pullback, we haven't seen the contagion that you might expect," said Grogan.

"At the moment it's ring-fenced to equities, the question is if it spreads to other risk assets. That's where it gets interesting."

Additional reporting Bloomberg

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