Markets stumble, then find their feet - for now…
The major story of the past week - or "non-story" depending on how you look at it - is that the sky has not quite fallen in (much like the member for New England) after the US market's sudden spike in volatility earlier in the month.
Inevitably there will be those who will be saying "what was that all about, it was just an over-reaction, and now there's a great buying opportunity!"
That may be, but as Hedge Clippings warned a couple of weeks ago, don't risk betting the house on it. The US market, having risen for 12 straight months, including over 5% in January, was approaching the "irrationally exuberant" stage, underpinned by low/zero/negative interest rates (depending on where in the world you are), the promise of US tax cuts and infrastructure spending, low inflation, and low wages growth, all of which are feeding into an improving economy and corporate earnings.
The canary in the mine is the 10 year bond yield at over 2.8% (and rising) vs the S&P500's 2017 yield of 2.4%, and an uptick in inflation. Perversely this is precisely what the FED has been trying to achieve. The renewed volatility (the VIX having traded around 10% for a large part of the last 6 months) was a useful warning shot across investors' bows, and luckily for them, the market seems to have stabilised - for now - rather than going into free fall.
While the economy and corporate earnings continue to improve, that won't fully insulate the market from an impending switch in asset allocation as the US10 year bond yield moves to 3% and above - which it will at some stage, and probably in the not too distant future.
Locally the damage to the Australian market was not as great, simply because in 2017 it had only risen half as much as the S&P500, but it still wasn't immune to the volatility. While it's only halfway through February, there'll be the usual wide range of fund results come the end of the month, but many absolute return funds had either short positions, or were carrying a high level of cash as at the end of January. As such their relatively low net market exposure will buffer them from the volatility, proving their worth in rocky markets.
