Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

The phoney war in the markets got real this week. After two months of steady gains for share prices, volatility has returned with a vengeance. You’d be forgiven for feeling unsteady after some big swings in sentiment.

The turmoil began 10 days ago when the Federal Reserve’s chairman Jerome Powell ended the US central bank’s rate-setting meeting with an unvarnished assessment of the outlook for the US economy. He expanded on that theme earlier this week when he painted the same picture in testimony to the US Congress.

When the chairman of the Fed speaks, the market tends to sit up and notice. That’s even more the case when his gloomy outlook comes just as prices had recovered all the ground they had lost since the start of the pandemic crisis. His words triggered a major reassessment of whether the recent market rally could really be justified by events in the real world.

After weeks in which Wall Street had led the charge, Main Street reappeared on investors’ radars. The Dow Jones index fell by 7% in one day - a wake-up call if ever there was one.

This week also began on the back foot after the medical headlines out of China and the US added to the economic worry. Fears of a second wave of infections have lurked in the background throughout the recent market rally and a renewed outbreak in Beijing and rising numbers of cases in Florida and Texas were a reminder that the coronavirus is down but not out.

What’s been confusing for investors is the variety of market-moving news recently. It’s a real case of sunshine and showers, with scary headlines interspersed by some unexpectedly good news.

A couple of weeks ago, the US labour market took everyone by surprise. With economists bracing for 7.5m more job losses, the addition of 2.5m was totally unexpected. Even in a big market like the US, a 10 million gap between forecast and reality is a big deal. This week, too, the retail sales figures in America, up 18%, suggested an economy that’s returning to normal much more quickly than feared.

No sooner had investors absorbed that news, however, then the UK jobs data told a very different story. A slump in vacancies and rising jobless claims made it clear that a flat unemployment rate was a statistical anomaly. Once the furlough scheme is unwound, the jobs market in the UK is going to look ugly.

That’s a confusing picture for investors. It goes some way to explaining the mismatch between the headlines and the level of the stock market. And it helps explain why markets are so up and down right now. Investors are struggling to make sense of things.

There’s clearly a tug of war going on between the mixed headlines on the one hand and the unprecedented stimulus that governments and central banks are providing on the other. Here, too, there was fresh news this week.

First, the Federal Reserve announced the implementation of a plan it had initially unveiled a couple of months ago to buy corporate bonds in the market. The idea here is to keep the yields on those bonds low and so to reduce borrowing costs for companies. Given that corporate solvency is a big worry for equity investors, too, this is a major positive for all markets.

Second, Bloomberg reported that the US government is considering a huge $1trn infrastructure investment plan that evokes memories of President Roosevelt’s Depression-era New Deal. If it doesn’t pay to fight the Fed, it is almost certainly wrong to fight both the Fed and the US government when they are working in tandem.

By comparison, the Bank of England pumping in another £100bn to the UK economy, also announced this week, is small beer but it sends a clear message: the authorities are determined to do whatever they need to keep the economy on an even keel.

Here are another couple of reasons why markets are not behaving as you might expect if you simply look at the economic fundamentals.

First, there has been a rise in so-called systematic investing. This is where big institutional investors add to or take away money from the market as it moves up and down. They tend to add to their market exposure when prices are rising and reduce it when they fall. This naturally exacerbates existing movements and causes the market to overshoot in both directions.

This explains why the market fell so far, so fast in February and March. It has also contributed to the recovery in prices such that an influential survey of fund managers this week showed the majority of those questioned believe the market is overvalued but may stay that way.

Second, it is important to understand the growing influence of technology stocks on the market. A handful of familiar tech names - like Apple, Microsoft and Amazon - now account for a quarter of the value of the S&P 500 index. Because these companies have been beneficiaries of the new world of working from home and the need for greater online connectivity, they are dragging the overall index higher on their coat-tails.

So, how should investors respond to these confusing market signals? Three ways:

1.  First, don’t look for the daily news headlines to provide a guide to where the market might be headed in the short-term. Investors always try to look through the current crisis to what things will look like in a few months’ time. That will involve making judgements not just about what’s going on in the economy now but also what the authorities are doing about it.

2.  Second, accept the limitations of your knowledge and don’t try to time the market’s movements in the short-term. With the best days for prices often coming hard on the heels of the worst, the chance of being caught on the wrong side of the changing market mood is significant. Much better to keep investing systematically and regularly, dripping your money into the market through the inevitable ups and downs.

3. Finally, be well-diversified. Growth companies have outperformed value stocks but may not continue to do so. The US has outpaced the UK, Europe and emerging markets but may not in future. Putting your eggs in a variety of baskets - across different asset classes and geographies - will give you a smoother ride.

More on Coronavirus and volatility

Five year performance

(%) As at 17 June

2015-2016

2016-2017

2017-2018

2018-2019

2019-2020

Dow Jones

10.4

37.5

14.9

12.0

1.9

Past performance is not a reliable indicator of future returns

Source: FE, as at 17.6.20, total returns in GBP terms

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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