And breathe…markets bounce back

Maike Currie
Maike Currie
Fidelity Personal Investing7 February 2018

It’s been a hairy few days on markets marked by dramatic falls across the globe and mounting talk of the end of the mighty bull market. Today calm has been restored and across the board markets seem to be staging a rebound. The rollercoaster ride would no doubt have left investors feeling a bit frazzled. If you’re wondering: ‘what just happened?’, here are four key takeaways from the past few days:

1. The stock market and the economy are two different beasts

Things really kicked off last Friday when a piece of good economic news - a stronger US jobs market and a pick-up in wage growth - was interpreted as bad news for the stock market.

The reasoning was that if Americans were earning more, they’d spend more and that would push up prices and lead to inflation. If inflation returned with a vengeance, the Federal Reserve (the US central bank) would need to step in and push up interest rates quicker than expected to keep prices rises under control.

Rising interest rates can have a depressive impact on stock markets because it means investors tend to move their money away from more risky areas (i.e. company shares) to safer assets (i.e. cash and bonds) because they are able to secure better returns with less risk.

The lesson here is that the stock market and the economy don’t always move in lockstep. We’ve had strong company profits and economic growth for some time now, but while the stock market might have wobbled the global economy is in no worse shape than it was two weeks ago.

2. Central banks kill bull markets

Just because the global economy is in good shape, doesn’t mean that the fast and furious falls of the last few days didn’t hurt. Investors have long been nervous about the bull market coming to an end - after all this has been the second-longest running bull market in the post war era. But bull markets don’t die of old age - they’re killed off by central banks.

The US market wobble coincided with the first day on the job for the new chairman of the Fed, Jerome Powell, after a weekend when his predecessor, Janet Yellen, let it be known she was disappointed in not getting a second term from president Donald Trump. A lawyer and an investor, Powell is the first Fed chair in that 40-year period not to have an advanced economics degree. Some argue that the markets might have wanted to have a more experienced hand on the tiller at the moment.

Yellen’s four years in office have generally been seen as a great success. She has managed the Fed’s twin mandates - controlled inflation and the promotion of full employment - while reversing policy from monetary easing to modest tightening. And she managed to do this with skilful communication that has - until now anyway - not spooked investors. Whether her successor will be able to do the same, remains to be seen. Either way, he has his work cut out for him.

3. Stock markets go up, as well as down

As investors we’re constantly told that ‘markets can go up as well as down’. But with 2017, being a year of almost all up and very little down, many investors might have forgotten the last bit.

Last year was a vintage year for investors with most markets hitting new record highs with very little shocks along the way. It would have been unreasonable to expect this year to be more of the same. As James Bateman, CIO Multi Asset at Fidelity International puts it, what we have witnessed is a sign of real health in the markets. He explains: “The tech-fuelled rally in the US had long lost any sense of reality in its valuations, the prospect of inflation remaining low forever could not last, and we have a new and untested Fed Chair. It would be more worrying if markets didn’t react to all of this.”

If anything, the falls of the last few days serve as a timely reminder that corrections are a normal feature of stock markets; it is normal to see more than one over the course of a bull market. Today markets are staging a rebound, showing that a stock market correction can be a good time to invest in company shares as valuations become more attractive, giving investors the potential to generate above-average returns when the market rebounds.

4. A word on volatility, and volatility-based strategies

The focus for many investors during the roller-coaster day on Tuesday was the Vix volatility index, Wall Street’s so-called fear gauge, which briefly shot to its highest level since the 2015 Chinese currency devaluation.

This was in stark contrast to last year with the Vix ending 2017 at its lowest point on record, reflecting the eerily calm conditions enjoyed by investors. The record low volatility which dominated much of 2017 also gave way to a popular investment strategy: selling volatility, whereby investors make money when markets are calm. These so-called ‘low volatility trades’ have been packaged into exchange-traded notes, which makes buying into the strategy as simple as buying a stock. As volatility spiked this week, investors in these products were caught on the wrong side of the trade and lost almost all of their money.

There are two important lessons from this. One: from time to time, there is inevitably volatility in stock markets as investors react nervously to changes in the economic, political and corporate environment. Be prepared at the outset of your investing journey for episodes of volatility. And, two: as we learnt during the financial crisis - invest in what you know and make sure you, and the funds you’re invest in, steer well clear of esoteric, packaged-up products.

Important information

The value of investments and the income from them can go down as well as up, so you may not get back what you invest. When investing in overseas markets, changes in currency exchange rates may affect the value of your investment. This information does not constitute investment advice and should not be used as the basis for any investment decision nor should it be treated as a recommendation for any investment. Fidelity Personal Investing does not give personal recommendations. If you are unsure about the suitability of an investment, you should speak to an authorised financial adviser.