What’s behind 2018’s stock market mood swings?

By: Tim Bennett
So far this year, stock market investors seem to have been spooked by three factors says Tim Bennett. Here he explains what they are and how to manage them.

What’s behind 2018’s stock market mood swings?

After the stock market’s big downward lurch in February, investors may be asking what lies ahead in 2018, especially after the relative calm of 2017. Whilst no-one has a crystal ball, we can safely say that investors should be ready for a rockier ride from stocks this year. We can also say that this is not something most investors need to worry about, provided you are correctly positioned to weather it.

All change

A glance at a couple of charts reveals the extent of the change between last year and this. Here is the S&P 500 and the FTSE 100.
A gently rising 2017 line, in both cases, becomes a much wobblier one as we cross into 2018. And it’s the same pattern if we look at the volatility indices for both markets;
The spike on the right is February 2018 and volatility has been higher than last year ever since. So what’s been going on?

Key factors

The blame for this burst of unease can be laid squarely at the door of three factors. It is worth noting that none of them are brand new per se but nonetheless they have, in combination, given investors pause for thought.
Let’s take each in turn in a bit more detail.

Monetary policy

Last year, it seems that investors took rising US interest rates largely in their stride. This year they have been less inclined to do so. That’s because, although some of the domestic US and global indicators have been broadly positive, that presages the possibility of higher inflation and interest rates. Meanwhile, should the bears, who point inter alia to recent weak European data be proved right, the world economy may be on the brink of something sinister, perhaps even the next recession. Cue a tug of war between the two camps and more volatility.
Layered on top of that is the fact that no-one really knows how successfully quantitative easing will be reversed without upsetting the bonds markets. The US Federal reserve says it can manage the process smoothly but then, they would say that. Time will hopefully prove them right but not everyone is convinced.

Geopolitical risk

Next up, investors seem to have been spooked this year by rising risk from politicians. Although North and South Korea may have reached an accord recently, few are certain it can last and many suspect the motives of an, until now, anti-western North Korean dictator. Meanwhile, there is plenty else going on around the world to make investors nervous, not least the recent spike in the oil price caused by US/Iranian tension.

Inbuilt instability

My third factor is not so much a direct cause of greater investor unease as an amplifier for it. Two relatively new factors have been at play in the markets over the last decade. First off a bull market has bred a generation of investors who don’t know what big dips look like and are prone to panic when they happen. Secondly, an industry has developed around playing volatility itself. Some of the resulting products (“volatility inverse ETNs”) are so unpredictable that they had to be withdrawn altogether in February as markets briefly tanked.

What should you do?

Faced with this new period of heightened volatility, investors may consider two things. Firstly, volatility is not infact new, in the sense that it is part and parcel of equity investing. As such, it can be managed. The next thing to bear in mind is that whilst other investors may dabble with exotic, volatility-based products and you will see plenty written about them in the press, most of us can leave them well alone (the products and the headlines) and focus on the basics of getting our portfolio positioning right and adjusting it as market conditions change.