Mar­ket volatil­ity will be a con­stant fea­ture

The Pak Banker - - OPINION - Mo­hamed El-Erian

GLOBAL equity in­vestors got a much-needed re­prieve from volatile, loss-in­flict­ing mar­kets. But rather than sig­nalling the start of a calmer mar­ket phase, this may well prove a pre­lude to re­newed volatil­ity in the weeks ahead. Af­ter end­ing the last trad­ing ses­sion of the pre­vi­ous week with a gain, global stocks got off to a good start last Mon­day (Fe­bru­ary 15). US mar­kets went on to post their best weekly per­for­mance since Novem­ber, as two days of solid mar­ket ral­lies were fol­lowed by rel­a­tively calm con­sol­i­da­tion. Mar­kets in Ja­pan and some parts of Europe did even bet­ter, reg­is­ter­ing gains of 5 per cent to 7 per cent. There were four rea­sons for this respite from an oth­er­wise hor­rid start to the year: At­tempts by cen­tral bankers, es­pe­cially out­side the US, to re­as­sure mar­kets; stepped-up ne­go­ti­a­tions among oil pro­duc­ers aimed at stabilising prices; the rush by Euro­pean banks to avoid join­ing the set of un­hinged mar­ket seg­ments by com­ing up with mea­sures in­clud­ing re­pur­chases of their se­cu­ri­ties; and some, al­beit lim­ited, pos­i­tive US eco­nomic news.

Yet none of th­ese fac­tors serve to sig­nif­i­cantly counter, let alone, over­come three much big­ger and more con­se­quen­tial re­al­i­ties. First, cor­po­rate earn­ings will be fur­ther chal­lenged by con­tin­ued signs of spread­ing global eco­nomic weak­ness and a per­sis­tent in­abil­ity by gov­ern­ments to de­liver the re­quired pol­icy re­sponses. Last week, the Or­gan­i­sa­tion for Eco­nomic Co­op­er­a­tion and De­vel­op­ment joined other in­ter­na­tional eco­nomic watch­dogs in of­fer­ing lower growth fore­casts. It also noted ad­di­tional risks. Se­cond, the con­tin­ued abil­ity of cen­tral banks to re­press fi­nan­cial volatil­ity is in­creas­ingly in doubt. The in­sti­tu­tions that are will­ing to pur­sue such poli­cies, par­tic­u­larly in China and Ja­pan, are fac­ing ques­tions about their ef­fec­tive­ness. And more able cen­tral banks, such as the Fed­eral Re­serve, may not be as will­ing to do so, par­tic­u­larly given eco­nomic in­di­ca­tors sug­gest­ing that fi­nan­cial volatil­ity has not con­tam­i­nated eco­nomic ac­tiv­ity and that wage and price in­fla­tion are start­ing to pick up.

Third, al­though a few days of mar­ket gains can force traders to cover their shorts, in this case, it does not seem to have trig­gered the re­turn of the stabilising role of long-term cap­i­tal. In­stead, it would ap­pear from data about the flow of funds that mar­kets still need to reprice con­sid­er­ably lower to find the an­chor­ing in­flow of sig­nif­i­cant pa­tient cap­i­tal. Un­til th­ese three fac­tors change, oc­ca­sional pe­ri­ods of mar­ket calm - and, thank­fully, there will be some - are likely to prove frus­trat­ingly short. But this does not mean that in­vestors should just rec­on­cile them­selves to pas­sively rid­ing roller-coaster mar­kets that will likely cre­ate anx­i­ety and may even force some, dur­ing large air pock­ets, to liq­ui­date at the wrong time. In­stead, in­vestors would be well ad­vised to con­sider adding a tac­ti­cal com­po­nent to their longer-term strate­gic and struc­tural po­si­tion­ing. Given the like­li­hood of a re­turn of sig­nif­i­cant mar­ket volatil­ity, pe­ri­ods of down­ward pres­sure will con­tinue to be as­so­ci­ated with price over­shoots and un­due con­ta­gion. For in­vestors will­ing to stom­ach lots of mark-to-mar­ket risk, th­ese gy­ra­tions will of­fer an op­por­tu­nity to gain ex­po­sures at at­trac­tive prices to names pos­sess­ing solid eco­nomic and fi­nan­cial fun­da­men­tals.

And dur­ing the pe­ri­ods of up­ward re­trace­ment, th­ese same in­vestors will have the op­por­tu­nity to ac­cu­mu­late cash, while con­tin­u­ing to upgrade the qual­ity of their hold­ings. An­chored by the no­tion of "buy and hold", many long-term in­vestors will nat­u­rally re­sist adding a tac­ti­cal com­po­nent to their in­vest­ment ap­proach. But fail­ing to do so could also cause them to risk los­ing sight of a larger re­al­ity that volatile mar­kets are now sig­nalling in­creas­ingly con­sis­tently. The world is ex­pe­ri­enc­ing pol­icy and eco­nomic re­align­ments that un­der­mine two no­tions that have served "buy and hold" in­vestors well in the last few years: that global growth, while low, re­mains rel­a­tively sta­ble; and that sys­tem­i­cally im­por­tant cen­tral banks con­tinue to be both will­ing and able to re­press fi­nan­cial volatil­ity and boost fi­nan­cial as­set prices. This paradigm is com­ing to an end. More­over, what may fol­low is far from pre­des­tined, de­pend­ing in large part on whether politi­cians are able to bring about the much needed hand­off from ex­ces­sive re­liance on cen­tral banks to a broader pol­icy re­sponse. In the mean­time, we all bet­ter get ready for the re­turn of greater fi­nan­cial mar­ket volatil­ity.

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