NEW YORK: Are we having fun yet?
For two years traders bemoaned the tranquility in global equity markets. That era just ended in a fit of turbulence, as stocks plunged into the first correction since early 2016 and volatility almost doubled from historically low levels over the past three months. Dip buying no longer worked, and holding tight on the S&P 500 Index delivered the first quarterly loss in 2 1/2 years.
With the White House spoiling to reorder the global trade hierarchy and the Federal Reserve raising interest rates, the word on Wall Street is: get used to the swings.
“Think about all the waves and stress caused on the surface of the water when a boat is changing directions,” said Michael Cuggino, president and portfolio manager at the Permanent Portfolio Family of Funds in San Francisco. “You have a transitory period of changing directions in monetary policy and growth expectations. As investors try to sort through that, that creates volatility.”
Even though most of the market’s worries can be countered - after all, interest rates are meant to go up sometimes, stocks are meant to go down sometimes - the handwringing is amplified by the torpor that came before. The S&P 500 gained or lost 1 per cent in a single day 23 times this quarter; in most of 2016 and 2017, it went for months without a single such move.
The 81 per cent jump in the Cboe Volatility Index tells the story of a quarter when stocks went from euphoria to correction in a matter of weeks. Optimism over Donald Trump’s tax cuts triggered unprecedented inflows into US equity funds in January as the S&P 500 jumped the most in 22 months. Then, a popular short volatility trade blew up, triggering a 10 percent correction that wiped $2 trillion from US stocks.
March failed to calm nerves amid White House reshuffles, a trade spat with China and a slump in tech megacaps on concern over tighter regulatory scrutiny. The scorecard by the end of the quarter: the S&P 500 fell 1.2 per cent, the Nasdaq 100 Index rose 2.9 per cent, small caps slid 0.4 per cent. It was the worst stretch in at least a year for all of them.
“The market faces a lot of challenges - valuations are high, financial liquidity is contracting, economic surprises are weakening, investor confidence is too bullish and yields are rising,” said Jim Paulsen, chief investment strategist at Leuthold Weeden Capital Management. “The Fed tightening is bad, trade wars are bad, technicals are bad, but you hit my Facebook, Netflix, Tesla, i.e., ‘the popular’ stocks, now that is BAD!”
It remains to be seen how long the tech jitters last, but a source of volatility that’s likely to linger is concern over higher interest rates. Stimulus enacted by the Fed to revitalize the economy after the financial crisis has helped the equity market rally for more than nine years. While this month’s rate hike was widely anticipated and equities took it in stride, concern has been rising about how many more there’ll be this year.
So, what next?
Earnings are likely to give traders some confidence with the reporting season scheduled to start in April. Investors will get a first look at the benefit from Trump’s tax cuts, and the latest estimates are for S&P 500 profits to surge 17 per cent.
Concern over rising interest rates means that even though earnings will likely buoy the market’s bulls, volatility is unlikely to go away, according to Donald Selkin, New York-based chief market strategist at Newbridge Securities Corp.
“Last year was an abnormal year, so this year we’re reverting to the average for the VIX. We’re reverting to what’s the norm now,” Selkin said. “It doesn’t mean the bull market is over.”
