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Equity

Bear market jitters are a self-fulfilling prophecy

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After a year of predictions that a bear market is coming off the back of monetary policy normalisation, people shouldn’t be surprised that investors are a little jumpy.

In the classic children’s tale “We’re going on a Bear Hunt”, four intrepid and inquisitive youngsters go out looking for a bear.

They wade through rivers, long grass, forests and such before coming across the object of their quest, at which point they turn and flee at the sight of the fearsome animal.

The tale ends with the four children locked inside and hiding under their beds. 

It can be taken as a cautionary lesson that if you go looking for bears, you’re likely to find one.

Some buy-side equity investors were faced with a similar predicament over the last few days when coming face to face with what looked like a bear market, a market that many have been looking for and predicting would come.

The cause of the huge sell-offs seen in global equities seems to be an improving US economy and jobs report data which suggests the Federal Reserve will raise interest rates faster than had been expected.

The rise in US Treasury yields certainly points to market conditions returning to historic norms and central bank stimulus ending, but this again is primarily because of what is seen as improving economic fundamentals.

The much debated US tax cuts are also likely to spur on the economy, which shouldn’t be a negative for US corporate earnings.

Global economic growth is also positive but despite this almost all global equity markets are in free fall, some like the FTSE 100 wiping out a full year’s worth of gains.

Perhaps it is fitting that a stock market boom which many cited as illogical should be hindered a little at the start of the year by a sell-off which is equally devoid of reason, while improving economic fundamentals should stop the plunging prices becoming a true crash.

Investors have been more vocal than banks and analysts over interest rate fears and worries that a rising rate environment would cool an overheated market.

The claims have almost become lore and it should therefore be no surprise that they are coming to fruition, once the normalisation, which everyone knew was coming, seems to be coming down the pipeline.

High corporate leverage levels and rising household debt are certainly concerns for credit investors, but there isn’t any clear economic reason for equities to be selling off fast, other than simple a change in sentiment.

This isn’t 2008, or even 2002, where an underlying asset bubble is ready to pop (Bitcoin excluded), and there isn’t an identifiable trigger for markets to crash.

“While the trigger and, for that matter, the timing of any sell-off is always difficult to anticipate, it had become clear for some time that this rally had become long in the tooth and was due a breather,” Abi Oladimeji, CIO at Thomas Miller Investments said in an emailed statement. “Investors need to put the selloff in context. As at the close of trading on Monday 5th February, the S&P 500 index had lost 7.8% from its January peak.

“Nevertheless, it has gained almost 18% in price terms over the twelve months to the end of Monday February 5."

Oladimeji added that all evidence suggests that this week’s sell off is little more than a “correction of excess investor exuberance” rather than anything sinister.

“Before long, once the ‘weak hands’ have been shaken off, the underlying positive trend is likely to resume, hopefully, at a more sustainable pace if we are to avoid a more protracted risk-off event in the not-too-distant future,” he concludes.

Volatility, though, is still expected and the CBOE Volatility Index (Vix), a popular measure of expected volatility, has hit levels not seen since 2012 and 2002, without a sovereign crisis or dot-com bubble burst to drive it. 

Evidence-led growth in equities driven by underlying earnings and macro seems to have been forgotten in a market obsessed with bulls and bears. 

Once markets and monetary policy stabilise, rationalists will hope improving economics lead to a moderate equity recovery supported by core fundamentals.  

In the tale of the children on a bear hunt, much debate has been dedicated to whether the bear was ever real in the first place or just spurred on by an active imagination.

Perhaps the same can be said of the bulls and the bears in equity markets.

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