Fixed Income Research & Macro Strategy (FIRMS) from Olivier Desbarres at 4X Global Research
- The multi-year rally in US equities has set numerous records but so did the downturn on 2-5 February and the rise in until now dormant volatility.
- The underlying cause(s) and trigger(s) behind this sell-off and jump in market volatility will arguably colour policy-makers and markets’ reaction functions going forward.
- The global macro backdrop remains been pretty healthy, with US GDP growth robust if unspectacular, global GDP growth at multi-year highs and central banks’ monetary policies still stimulative in aggregate.
- There are clearly lingering issues at a country and global level but these potential flash-points have lurked in the background for months without overtly worrying equity markets.
- The simplest, if not necessarily most compelling reason for this sharp equity correction is that equity markets were “over-valued” – however tenuous this measure of relative value.
- A more fundamental explanation is that markets had become increasingly concerned that rising global growth and commodity prices would rapidly translate into higher inflation, requiring central banks to hike their policy rates more forcefully than currently priced in – a malaise most evident in the vertiginous rise in 2-year US yields and flattening curve.
- This was equivalent to layers of snow rapidly gathering on a sharp slope, with the release of multi-year high US hourly earnings growth in January triggering the equity avalanche.
- This was a seemingly benign snowflake, suggesting that markets may have been looking for a reason, however slim, to exit equity positions and that stocks could weaken further on the back of slightly better-than-expected economic data or even a modest repricing higher of central bank rate hikes. After all the Dow Jones saw only 37 sessions of gains wiped out over these two sessions and was as of 8th February still up 0.7% year-to-date.
- History suggests that policy-makers have been unwilling or powerless to prevent equity downturns in the first place. We argued this point in Plan B (5 December 2017) and do not think the current situation is materially different.
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