Putting the volatility into context

Putting the volatility into context: Dr. David Stubbs and Alex Dryden, JP Morgan

August 2015

Fears over global growth, particularly in China, political uncertainty in Greece and the potential for rising interest rates in the US look to have spooked markets. After falling nearly 6% last week, their biggest weekly decline in over four years, global markets continued their rout on Monday 24th August, with the Chinese stock market falling by close to 9%, triggering heavy selling in other markets around the world.
Putting this volatility into context:

• The index for the European stock markets (the MSCI Europe) fell 6% last week, eroding much of the gain it had made this year. At the start of April, European equities were up over 15% year to date; they are now up just 1%. This fall represents an intra-year decline of 13%.
• However, intra-year declines of 13% or worse are not unusual at all. Over the past 35 years, markets have, typically and on average, experienced a 16% intra-year decline; however, in 27 of the past 35 years, the markets then rallied to finish up on the year.

What’s behind the sell-off?

The market weakness does not appear to be associated with any one event, but rather seems to be the result of a few factors:

• Falls in commodity prices, and the continuing collapse of the Chinese stock market, have led some to believe that global growth is weak and slowing sharply. Oil prices, for example, are now at 6-year lows.
• The narrative around weaker growth in China and emerging markets more broadly has spilled over into commodity and currency markets, causing a new wave of risk aversion.
• Low liquidity in summer markets is amplifying the sell-off. Furthermore, a lot of the more experienced, more sensible heads are sitting on a beach rather than in the office, which could also be contributing to the sell off.
• Uncertainty around the timing of Federal Reserve “lift-off” for interest rate rises continues to give the markets indigestion; markets hate uncertainty, and this is a key area of confusion.

Investment implications

• Significant falls are part of the nature of equity investing and occur in most years. A fall of this size is not uncommon in years that ultimately deliver positive returns to investors.
• While there are clear challenges in commodity markets and some emerging market economies, these are well defined and do not reflect a major deterioration of economic growth or corporate earnings in most of the developed world.
• Therefore, this sell-off is creating opportunities for investors to buy quality companies, with bright earnings outlooks, at lower valuations than just a few weeks ago. Differentiating between regions and sectors primed for further growth, and those that will struggle, will be key for investors today and in coming years as the bull market continues to mature.
• The rally in safe-haven assets and currencies demonstrates once again the importance of diversification as a tool of risk management.