Volatility revisited

As Warren Buffett once sensibly pointed out, “Anything can happen anytime in markets.” And how he was proved right last month. Months of unbroken calm were rudely interrupted by an explosion of volatility as the VIX index of volatility in the S&P 500 suddenly surged up to 50, its highest level since August 2015. The S&P 500 fell 2.1% in just one day, a sell-off which then spread to Asia and the UK. A nail-biting week or two ensued as markets jerked up and down. The bustle of buying and selling moved across time zones and investors shed a tear as equities waved a sorry farewell to their gains year to date. In February, there were eight trading days resulting in a move (up or down) of more than 1% in the S&P 500; the same number as the whole of 2017. It was tense stuff. 

The sleepless nights didn’t last long. February did close to the downside across major markets, but VIX volatility has calmed back down to its long-term average of 20. In hindsight (and isn’t hindsight a wonderful thing), potentially the most surprising part of this commotion, is just how surprised everyone was. Markets have been eerily quiet for an eerily long time; surely some turbulence simply marked a return to norm? 

February probably won’t be the only rocky month of the year; we don’t expect volatility to go into hiding again in 2018. Some turbulence seems natural as central banks begin to gradually tighten their monetary policy, so strap in and hold on. But we think that the global economy is strong enough to deal with some cautious tightening. We may be able to wave those bears goodbye as they skulk off to find an alternative outlook to darken. Growth is strong, company earnings are healthy and consumers all across the world are resilient. 

 Index   1 month  3 months  6 months   1 year  FTSE All-Share -3.3 % -0.6% -0.9%  4.4%  FTSE 100 -3.4% -0.5% -1.2% 3.4%  FTSE 250 -2.7% -1.0%  0.4% 7.7%  FTSE SmallCap -3.1% -0.6% 1.0%  10.9%  S&P 500  -0.7% 1.0%  3.4% 5.1%  Euro Stoxx  -2.8%  -1.1%  -1.0%  14.9%  Topix 1.7% 1.9%  6.5% 11.4%  Shanghai SE -4.0% 0.8% -5.4% -1.5%  FTSE Emerging -1.1% 6.7% 3.3% 15.5%

Source: FE Analytics, data sterling total return to 28 February

The global PMIs out this week signalled a further acceleration in the rate of expansion in global economic output. Growth hit a near three-and-a-half year high, as inflows of new business strengthened. The report suggested that global growth should remain solid in the coming months. 

Rising volatility will create opportunity, as long as you choose carefully. We’ll be on the lookout. 

On the way up

US Treasury yields jumped as global inflation picked up and US growth estimates were positively revised. So far signals have been a bit mixed from new Federal Reserve (Fed) Chairman Jay Powell, who rowed back on some initially hawkish commentary, prompting speculation about the trajectory of rate rises in the US. We await further clarity from the Fed’s mid-March meeting. 

Speculation has been rife about the path of rate rises this side of the Atlantic. Inflation held at 3% in January, not falling as expected, and last month’s inflation report from the Bank of England revealed a hawkish shift, leading most economists to now expect a rate rise in May, with further increases to follow. 

Don’t hold your breath though; real wage growth has turned negative and UK consumers have taken on a lot of credit which many would find unaffordable should rates rise. The UK economy actually grew more slowly than originally thought in the fourth quarter of 2017, with GDP growth revised down to 0.4% from an initial estimate of 0.5%, putting the UK at the bottom of the G7 league table. The BoE will risk extinguishing our meagre growth if it tightens rates too fast or too soon. 

Making protectionism great again? 

Following the month end, as if to prove Buffet’s adage, the calm that had returned to the markets was suddenly interrupted by US President Donald Trump’s seemingly out-of-the-blue announcement that he planned to order tariffs on imported steel and aluminium in a bid to protect his domestic industries. He also suggested a tariff on EU cars, which the EU responded to with proposed tariffs of its own. 

The President tweeted that trade wars “are a good thing”, and “easy to win”, but apparently his top economic adviser, Gary Cohn (who was regarded as ‘the only adult in the room’), didn’t agree, resigning shortly after the proposed tariffs were announced. Markets fell on the news of his departure, with less orthodox trade advisers, such as Peter Navarro, left in charge. 

History is not on the President’s side. The widely accepted view among economic historians is that the Smoot-Hawley Tariff Act of 1930 exacerbated the Great Depression. To students of British economic history it will feel like the clocks have been turned back 200 years to the disastrous Corn Laws of 1815. Though designed to protect domestic producers, they reduced disposable income, hampered growth, contributed to famine in Ireland and were ultimately repealed.

We hope the ‘tariffs are great’ act of 2018 will come to a quicker end. But all of this trade uncertainty, on top of Brexit, further supports our view that 2018 is likely to be a more volatile year than the one just gone. Though we remain vigilant, we expect continued growth in the global economy, and would see further bouts of volatility as an opportunity to find good quality long-term investments at better prices. 

Bond yields

 Sovereign 10-year  Feb 28  Jan 31  UK   1.50%  1.51%  US  2.71%  2.71%  Germany   0.65%  0.70%  Italy   2.07%  2.02%  Japan   0.05%   0.09%

Source: Bloomberg

 

Julian Chillingworth, Chief Investment Officer