Five things you need to know about the current market turbulence
Global markets experienced significant turbulence last week, with the Dow experiencing falls not seen since 2008. While in the moment these falls might seem unusual, it’s the low volatility of the last two years that’s truly unusual. In today's article, I share five key points to know about this turbulence.
It’s not unusual
While we have seen some large falls in global share markets over the past two days, these falls are not unusual in the context of market corrections. What has been unusual has been the historically low volatility seen over the last couple of years. The recent fall has only taken most markets back to levels seen in the second half of 2017 — and in some cases earlier this year.
It’s not a surprise
We have been of the view for some time that there was a significant and growing mismatch between potential downside risk due to valuations and volatility, and are accordingly defensively positioned. Relatively extended valuations in key equity markets — especially the US — and very narrow credit spreads made the market vulnerable to any news that derailed the strong growth, low inflation, accommodative policy backdrop embedded in pricing.
Inflation remains a key issue
The key challenge to this thinking has been inflation, with strong global demand (helped along by the US tax cuts) and growing evidence in both the hard and soft inflation and wage data (especially in the US) of a more pervasive rise in inflation, challenging current policy settings and relatively benign central bank rhetoric. Rising inflation and rising yields changes the relative pricing of assets classes, making bonds more attractive compared to equities, but also makes it more difficult for central banks to maintain what are still unusual levels of policy accommodation.
Bonds reclaim some ground, for now
Bonds have retraced some of the recent sell-off amid a “flight to safety”, and some investors are questioning the potential for the Fed to tighten if markets are unravelling, but we do not think the bond rally will extend given the challenge posed by rising inflation risks.
It was possible to prepare for this
While we do not know how long this volatility/correction in risk assets will last, we are relatively well positioned having increased defensive positioning in light of demanding valuations and growing confidence in our thinking about rising inflation.
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Simon is responsible for Schroders' Australian Fixed Income and Multi-Asset capabilities. He has direct portfolio management responsibility for the Schroder Real Return Strategy, Schroder Balanced Strategy and Schroder Fixed Income Core-Plus Strategy