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Financial Expertise

Chief Investment Officer Call: Market update in the wake of the short volatility mini crash

Financial Expertise

Chief Investment Officer Call: Market update in the wake of the short volatility mini crash

Yves Bonzon, Julius Baer’s Chief Investment Officer and Head Investment Management, shares with you his latest view on the recent market correction.

At a glance:

  • Global equity markets have corrected sharply lately.
  • The fact that credit markets have not shown signs of a crack so far and that the setback was not triggered by fundamental data make us confident that this is a healthy correction.
  • The decline in asset prices reduces the risk of a policy mistake by the Federal Reserve (Fed), which is likely to act more cautiously now.
  • Monday’s clear reversal in US Treasury bond yields again shows the merits of holding US Treasury bonds in a diversified portfolio.

Equities take a dive
In the past few days, global equity markets have corrected sharply. From their recent peaks, major indices such as the S&P 500, the Stoxx 600 and the Nikkei were down by 10%, 8% and 12% respectively. At the same time, equity market volatility has spiked. The selloff was triggered by the relentless rise in US Treasury yields, magnified by forced liquidation of excessive short volatility exposure in the markets. Coupled with Friday’s wage growth data, which was above expectations, this was enough to trigger risk assets liquidation with a snowball effect. We consider this market dive as healthy in the medium-term that is likely to prolong the bull market. Also, the decline in asset prices reduces the odds of a policy mistake by Fed, which could act more cautiously now.

Fed remains upbeat
At last week’s Federal Open Market Committee (FOMC) meeting, the Fed left its monetary policy unchanged, as expected. The Fed acknowledged that the economic activity and labour market continued to strengthen. Also, it sounded more confident that inflationary pressures will re-emerge soon. It expects inflation to further increase and stabilise around its 2%-target over the medium-term. The wording of the statement paves the way for further interest rate-hikes in coming months. Due to the annual rotation exchange of the four voting members of Fed district banks, the Fed may become more hawkish going forward.

Strong US labour market report
The US economy created more jobs than expected in January, while the unemployment rate stayed at an 18- year low for the fourth consecutive month. At the same time, average hourly earnings rose more than anticipated. Wage pressures have slowly been building as the labour market has become tighter. The surprisingly strong advance may partly be the result of special factors, however. As from this year, 18 US states have higher minimum wages. Also, some companies have announced bonuses and salary increases following the passage of tax cuts. Therefore, it remains to be seen whether wage pressures are really picking up.

Positive corporate earnings reports
In the US, clearly more than half of all S&P 500 companies has reported their results for the fourth quarter 2017 yet. Consensus earnings expectations, which have been steadily revised up in the past weeks, have been beaten by about three quarters of the companies reporting. The earnings of technology and healthcare companies were particularly positive while real estate and energy companies were lagging. In Europe, the corporate earnings reporting season is still in a relatively early stage as about a quarter of all Stoxx 600 companies has reported so far. Slightly more than half of all companies reporting has beaten the ambitious consensus estimates yet. Overall, the corporate earnings reporting season has surprised positively so far. Corporate earnings continue to be supportive for equities for the time being.

Chinese leading indicators send mixed signals
In China, leading indicators for January were mixed. The official Manufacturing Purchasing Manager Index (PMI) slightly eased, while the official Non-manufacturing PMI was a touch higher. The gauges for small and medium-sized companies, the Caixin Manufacturing and Service PMIs, showed a similar picture. Overall, they suggest that the solid growth environment is likely to continue. However, since the manufacturing PMIs are only slightly above the 50-mark, concerns about the longevity of the reflation cycle have risen lately. We continue to expect a slightly easing growth dynamic in the months ahead as the authorities are continuing their deleveraging efforts and are pursuing the transition from an investment- to a consumption-led economy. This is seen as a positive step in the right direction and should pay off in the medium- to longer-term.

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