Investors have become accustomed to a quiet, easy ride in markets – which makes the recent equity correction feel that much more alarming. Market volatility, as measured by the VIX volatility index has been stuck at unusually low levels and the extraordinary January rally in the US seemed to confirm the complacency. Market corrections are the investors’ equivalent of an ice bath, a healthy and effective antidote to complacency and quite normal.
Market corrections – a healthy antidote to complacency
This correction is a symptom of a stretched bull market that has been moving up in the face of higher oil prices, rising inflation and higher interest rates and it was overdue. Pricing these issues into equities is appropriate, but in themselves they do not presage a bear market.
The global economy is performing very well, monetary policy remains very accommodative and equities still offer meaningful returns for long-term investors. Valuations in Europe, Japan, Asia and Emerging Markets suggest average long-term return and traditional safe haven government bonds continue to be an unattractive option.
A sharp reminder that the markets have teeth
There have undoubtedly been some excesses in the markets of late. Short volatility products have blossomed as the VIX volatility index collapsed, cryptocurrencies reflected abject complacency and high yield debt covenants have been diluted to the point of irrelevance. A sharp reminder that the markets have teeth is an excellent way to minimise this “irrational exuberance” and allows solid fundamental factors to reassert themselves.
A return to normality in the year ahead
The changing macroeconomic conditions, particularly the normalisation of monetary policy and the return of inflation do reflect a change in the investment environment and the recent sell-off acknowledges this. The year ahead is likely to be more volatile as a result but is essentially a return to normality.
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This article was previously published on Tilney prior to the launch of Evelyn Partners.