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Corrections only turn bears in recessions

Equity markets had a rough month to date as the worries around rising inflation, bond yields and a more aggressive Fed continued to impact. US shares last week fell 5.2%, Eurozone shares fell 5.1%, Japanese shares lost 8.1% and Chinese shares fell 10.1%.

Bond yields were little changed over the week though as safe haven buying kicked in limiting their upside. Commodity prices generally fell, apart from the iron ore price, and a resurgent US dollar.

While inflation, Fed and bond yield worries were the trigger for the share fall, its rapidity owes much to the unwinding of a huge build up in so-called short volatility positions through exchange traded vehicles like XIV that collapsed circa 90% in value as volatility measured by the VIX index surged.

From their recent highs to the lows share markets have fallen 11% in Japan, 10% in the US, 9% in Europe and 13% in China. The severity of the falls globally with markets having got oversold, and the VIX volatility index pushing up to levels often associated with market bottoms, suggest we may have already seen the worst.

However, with bond yields likely to back up further and uncertainty around how much the unwinding of short volatility positions has to go, further weakness cannot be ruled out in the short term and volatility is likely to remain high. 

Still, the view remains that in the absence of a US or global recession, which are unlikely, the pullback is just another correction. It may feel worse because there has not been a decent one for a while.

Some things worth bearing in mind, though, around the pullback are that: corrections are normal; they usually don’t turn into deep bear markets unless there is a recession; selling after share market falls only locks in a loss; pullbacks provide an opportunity because shares are now cheaper; and while share prices may have fallen, dividends have not, so the income yield from shares is actually up.

Investors also have to keep in mind that a stronger Europe is on the way if a Merkel/Social Democrat agreement to form Government is approved. Angela Merkel and the SPD have reached an agreement to form government with the very pro Europe SPD taking the finance ministry.

If this is approved by the SPD membership it will clear the way for Merkel to work with French President Macron to build an even stronger Europe. This would ultimately be very positive for Eurozone assets. Eurozone share are probably the best bet in this scenario, and the recent correction has made them more attractive.

(Source: FinSec Partners)

Disclaimer: This article was issued by Antoine Briffa, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

 

 

 

 

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