SINGAPORE (Feb 12): Last week’s sharp plunge in stock prices has certainly jolted investors out of the complacency that has persisted through the better part of the past two years.
The Dow Jones Industrial Average (DJIA), the most closely watched index in the world, fell 666 points on Feb 2, only to be followed by a 1,175-point drop — the biggest one-day decline ever — on Feb 5. Meanwhile, the broader Standard & Poor’s 500 index fell as much as 9.7% in little over a week, fresh from hitting record-high levels on Jan 26.
The rout on Wall Street went on to trigger selling across Asian and European markets. The Singapore Straits Times Index and FBM KLCI fell 3.54% and 1.56%, respectively, over the past one week.
Not a surprise
Be careful what you wish for. The market plunge was particularly jarring since it brought to a halt one of the strongest starts to a year in recent memory. Those gains, and more, have since been wiped out. But at the same time, it really should not come as a surprise.
Such a correction, after the year we have had, had been long awaited and was a topic that had been written about extensively. There is no shortage of narratives predicting an end to one of the longest bull markets (nearly nine years) in history.
It is almost ironic that the trigger for the selloff was, in fact, a round of good news in the US. Investors, it appears, are finally pricing in the prospects of higher inflation, driven by stronger economic growth, a tightening labour market and, perhaps, ill-timed fiscal stimulus from tax cuts.
Yields on the benchmark 10-year US Treasuries have been rising, touching a high of 2.88% before falling back slightly as investors fled risky equities. (Bond prices and yields are inversely correlated.)
In Europe, the bond selloff reflects growing confidence in the economy and accordingly, expectations of eventual tapering by the European Central Bank. Normalisation of monetary policy underscores the recovery from the global financial crisis.
The CBOE Volatility Index, which spent most of 2017 hovering near record-low levels, jumped sharply higher in the last few days (see chart). It has risen to levels last seen in August 2015.
I suspect the intense selldown in markets may have more to do with the sudden sense of uncertainty with regard to inflation, rather than the actual level of inflation, which remains muted. While benchmark yields for US Treasuries are now at the highest levels in four years, they remain at the low end of the historical range. It is telling how used we have gotten to ultra-low interest rates.
Could this current rout turn into a more persistent downtrend? The last time global markets saw a meaningful correction was in January 2016. That turned out to be relatively short-lived and markets have since rallied to record highs. Every correction in the past two years has been shallow and short as investors took the opportunity to buy on dips.
There is certainly the risk that resurgent volatility will trigger a negative feedback loop, especially by passive funds and algorithmic trading. And owing to unprecedented easing by central banks and massive liquidity, bond, equity and commodity markets have been moving almost in tandem. That makes a reversal potentially more severe.
I have written extensively about the risks posed by the rise in exchange-traded funds (ETFs), an industry that is now valued at over US$4 trillion ($5.3 trillion) in a few short years. Not so much their size or growth over other forms of investing, but the concentration of risk and indiscriminate purchase of stocks to replicate the index without regard to underlying fundamentals and valuations.
As money goes into these funds, they will lift the index, which in turn attracts more money and on it goes. But this virtuous cycle could easily turn into a vicious cycle. Once investors start to pull their money out, the index will fall, prompting more redemption and further selling.
Of note, three US-listed inverse VIX ETFs were suspended on Feb 6 after suffering heavy losses. Funds invested in this type of ETFs, betting on low volatility, were no doubt burnt when the VIX spiked and likely contributed to the selloff. The real question is how widespread losses are and what the impact (if any) is on the broader market.
More volatility ahead
The volume of shares traded in the DJIA and S&P 500 component stocks from Feb 2 to 6 has been significantly higher than the preceding 30-day average. By comparison, traded volume was comparatively more “muted” in Malaysia, where ETFs are far less prevalent (see table).
Global markets rebounded on Feb 7, but we are likely to see more volatility in the days ahead before the dust settles.
It is my belief, however, that this will eventually turn out to be a healthy pullback; markets will recover and stock prices will trend higher in the medium term.
The global economy remains in good shape. Consumer spending will strengthen on the back of rising wages and job prospects, as will business investment. Inflation will rise gradually, but will remain muted. In other words, fundamentally, nothing much has changed in this one week.
In the US, the ongoing earnings reporting season has been, by and large, upbeat. The majority of the companies beat expectations — on growing turnover and healthy margins — resulting in strong upward revisions.
And to put the current selloff into perspective — dramatic headlines aside — the DJIA and S&P 500 are down 6.47% and 6.6%, respectively, from record highs. Still steep, but certainly not Armageddon.
It is futile to try to time the market. That is why I stick to the principles of value investing, by focusing on underlying earnings and prospects. These are the factors that will underpin the performance of a company and its shares in the long run.
My Global Portfolio fell 5.7% last week, mirroring the broader market selloff. Nevertheless, total portfolio value is still up 4.3% since inception. Over the same period, the MSCI World index is almost unchanged.
Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
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