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Market Update – February 2018

Volatility re-emerges

After more than 12 months of very benign market conditions, volatility has aggressively reasserted itself in recent days. Looking at the last 12 months in isolation, with volatility being consistently below 12, the jump to nearly 40 has come as a shock.



While well below the peaks of volatility experienced during the 2009 Global Financial Crisis as illustrated by the chart below, the sudden movement points to concerns in market.


The general sell-off was triggered by last Friday’s US report on jobs and wages growth. The Federal Reserve has made five, well sign posted interest rate hikes since December 2015, and new Federal Reserve Chair, Jerome Powell, looks set to continue Chair Janet Yellen’s cautious approach. But with the jobs report showing stronger than expected consumer spending and wages, US interest rates may need to rise more quickly.

Interest rates were effectively zero from 2008 to December 2015, they are now 1.5% and heading higher to around 5%.

There is also a more subtle theme at play: The US dollar – which is locked in a currency war between the US, China, Japan and Europe. The US generally has maintained a ‘strong dollar’ policy. However, on January 24 in Davos President Trump’s new Treasury Secretary Steven Mnuchin looked to depart from this long-held policy position, stating ‘obviously a weaker dollar is good for us’. While a weaker dollar is good for US exporters, a policy misalignment between Treasury and the Federal Reserve has caused market disruption in the past.

Treasury Secretary James Baker’s talking down the dollar in September 1987, was one of the main triggers in the 1987 crash. Then Bill Clinton’s first Treasury Secretary Lloyd Bensten talking down the dollar in early 1994, while Federal Reserve Chairman Alan Greenspan was raising interest rates, was a major factor in triggering the 1994 bond market sell-off.

There are some fears that a US dollar sell-off might trigger a major correction in bond markets, which has been expected for some time.

The question is what to do in response to this increase in market volatility?

Eq­uity markets will always be subject to cor­rections. The average annual drawdown in the Index since 1980 has, according to J. P. Morgan Asset Management’s very useful Guide to the Markets, been upwards of 14%. As recently as 2011, amid a blast of economic and political head­winds, it declined 19.4% in five months. And yet investors who have stayed the course have been rewarded with not only excellent capital appreciation but also with regular dividends, in most cases well in excess of interest returns achievable from cash.

In some instances, it may be opportune to top up quality holdings as value emerges. As always we are continuing to assess the impact on your portfolio and ensure that you are in the best possible position. Most importantly, we remain committed to ensuring that actions are driven by your long-term plan and not short-term market noise.