Market Comment: Bull market correction roils markets

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The market decline of last week turned into a serious market sell-off. Yesterday, late in the trading day, US markets saw a dramatic decline. Asian and European markets followed with downward market movements today.

Yesterday’s US market decline has been driven by systematic strategies and volatility-driven algorithms. These computer-driven trading systems, with pre-set ‘sell’ triggers, have exaggerated and extended the effects of the turbulence.

The origin of the market disturbance was strong US employment and wage growth data, which spurred inflation fears last week. US 30-year Treasuries rose to more than 3%, which was likely a sell-off trigger. Automated trading strategies will likely continue to dominate markets until the strategies are played out.

Not much impact other than in equities

So far, the decline is mainly limited to stock markets. No ‘domino-effect’ is expected. Credits and emerging markets bonds have seen only a very limited impact. We are relieved that what we see is a technical-driven decline and that there is little evidence of a firm sentiment that much higher interest rates or inflation is around the corner.  

In US Treasuries, for example, there is no large gap between two- and ten-year yields. This indicates that investors do not expect a swift increase in inflation. This same stance is also evident in equities. The very interest-rate sensitive utilities sector, for example, has not suffered unduly, while the financials sector, which would benefit from higher interest rates, has been pummelled. The increase in market volatility has seen inflows into the traditional safe-haven assets, such as gold, the Japanese yen and, to a lesser extent, the Swiss franc. Currency markets are also relatively stable.

Fundamentals remain solid

It is important to acknowledge that economic growth remains solid and that the fundamentals supporting stocks, including increased investment spending and strong earnings growth, remain in place. Despite the labour data of last week, ABN AMRO’s view continues  to be that inflation will remain under control and low compared to historical standards. Central banks and, in particular, the US Federal Reserve, will likely endeavour to anchor the markets to rational future inflation expectations and to reduce inflation anxiety.
Fundamentals, however, do not always drive markets. After such a strong and lengthy market run (beginning early last year), valuations had become demanding and complacency may have replaced an awareness of market and equity risks.

What should investors do?

We expect markets to stabilise in the coming days, and we continue to advise investors to stay put. If the decline in markets continues, buying opportunities will arise. But, we believe it is still too soon to step in. 

The one silver lining to this bull market correction could be that speculative investors, who have aggressively chased past performance, have now left the market. It would be positive for markets and investors if a new sense of prudence leads the way back to more normal market conditions, where risks are adequately priced. 

The Investment Committee will continue to closely monitor markets and remain alert to both the risks and opportunities that may arise.

Richard de Groot, Chair, Global Investment Committee