As falling markets hit the headlines should you be worried?

Just three weeks ago, the headlines were all about the US stock market hitting record highs. Having already been in an upward trajectory for almost nine years, the Dow Jones Industrial Index took just seven days to rocket from 25,000 to 26,000.

Fast forward 21 days and the headlines are now talking about “plunging stock markets” and “largest one-day points fall in history”.

While these headlines can be worrying, let's put the market falls of the past few days into perspective.

What has caused the falls?

The S&P 500 (another US market index) had actually set a new record for the longest period without a 5% fall. At 407 days, it overtook the dot-com boom of the late 1990s and was well beyond the long-term average of 92 days. So a correction of sorts was long overdue. And that is what we got yesterday. The US market was down 5% and these falls have spread to the rest of the world today.

The initial sell-off was sparked by better-than-expected US wage growth and employment numbers. Rather than focusing on the positives, investors appear to have fixated on a potential future downturn that may be sparked by faster and steeper interest rate rises.

As James Bateman, CIO, Multi Asset, at Fidelity International, said: But at this stage of the cycle, the money is made by keeping your head when others are losing theirs.

“What we have seen is perhaps the greatest sign of real health in markets for a long time. 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 head of the US central bank. It would be more worrying if markets didn’t react to all of this but in a world where equities felt like an unstoppable one-way bet for a while, the normality of a setback can feel more painful.”

What next?

Fundamentally nothing has really changed with the markets. Earnings have been strong and the global economy is doing well. Markets ran up too quickly and got quite expensive, but the US market is still at the level it started the year and remains up by around 50% since early 2016. In our opinion this current selling is to do with technical, rather than fundamental, reasons. We were due a correction and now we have got one.

James Bateman added: “It seems more likely that this pause for breath will lead to a reassessment of the market’s leadership. As ever, the role of central bank head is to walk a tightrope between prudence and sentiment. My money remains on equities - but rotating (and buying on weakness) into 'value' areas of the market that have lagged in the recent momentum-driven rally.”

James Clunie, manager of Jupiter Absolute Return fund agrees. Before Christmas he said: “Growth stocks have been the key driver behind the market’s performance recently, while value stocks have fallen. We have seen nascent signs of a reversal of this pattern, which could be important because a stock market rotation out of growth into value is something that has been witnessed in the run-up to a number of financial downturns, for example, in the late stages of the dotcom bubble, when stocks of technology companies were highly valued.”

Managers of TwentyFour Dynamic bond also believe the correction will be short-lived. “Last week we experienced something of a risk reversal. Just like in May 2013 when Ben Bernanke (then Chiar of the Federal reserve) gave us his taper tantrum, the answer lies in rising rates. The price action was fairly brutal and also widespread. This time, in our opinion, it will likely not be so brutal.

“The reason we think the price action will remain controlled is that the market is in a far better place today than it was almost five years ago. The world is enjoying its best period of growth since the global financial crisis and that growth is set to remain in situ throughout 2018 and 2019, unlike in 2013, when the fear of recession was always just around the corner. Technicals remain strong with the big four central banks holding over $15 trillion of low risk assets, with the result being too much cash on the sidelines leaving investors looking to buy dips, meaning that these dips have been shallow and short lived.”

What does this mean for investors?

Clive Hale, director at FundCalibre said: “We have seen periods of much greater weakness during this bull market run from the 2009 lows – 2011 and 2015-2016 in particular – so a very strong rebound, or a new all-time high is not out of the question, but that doesn’t mean that this is the time to abandon a defensive stance as the valuation and yield arguments still persist.

In our view investors should continue to pursue their long-term strategy and resist the temptation to make short-term, knee-jerk reactions. At this stage of the cycle, the money is made by keeping your head when others are losing theirs.