Markets May Just Have To Get Used To Weird Weeks Like This

What a week. If you’re a market regular, cast your mind back to Wednesday morning last week. As Asia Pacific markets opened, all was right with the world. Both the US and Chinese economies broadly on track, commodities markets bouncing back, local business confidence increasing. The Aussie on an upward march as overseas investors bought bonds and shares, and the share market sitting just below post GFC highs. To top it off, an international takeover bid for David Jones. The question wasn’t whether the ASX 200 would hit a new high, but how far would it go?

Fast forward to Monday morning. Two days of heavy selling in high momentum, high multiple stocks reversed sentiment completely. Share markets turned from boom to doom – on a pinhead. Market observers pointed to Russian expansionism, a potential need to stimulate the European economy, crumbling industrial metals prices and a possible miss on upcoming China numbers. Australian shares were down 2% in the previous two sessions – and went on to shed a further 1% that day.

Here’s how it looked on the charts:

Australia 200 Index – daily

A global issue for investors is that the underlying economic trends are not clear cut. In more normal monetary conditions, increasing growth rates are unambiguously good for share prices. But in current conditions, emerging growth means potential stimulus withdrawal. Add in the potential for inflation to rear its head after a long dormancy, and asset price reactions to events tend towards the unpredictable.

Further, the modest nature of the global recovery means economic data is likely to remain patchy. Sentiment and prices are likely to fluctuate significantly; meaning both bulls and bears can highlight reports and price moves that support their view. As investors in the middle switch from one camp to the other, sentiment swings could be more extreme. As sentiment swings, so should markets. The natural conclusion is that volatility will continue to increase, and to many investors it already feels that way. However, the numbers don’t back that up:

ASX 200 Index volatility – 90 day historic and implied

Both actual price moves (historic volatility) and the estimates of future moves used to price options (implied volatility) are near low levels relative to the last few years – and at 11-12% well below post GFC highs closer to 55%. If investors are worried about market volatility now, what will happen as daily fluctuations return to more average levels?

It’s possible markets are infected with an Australian linguistic disorder. For Australians, conditions generally are either great (“God’s own country”) or terrible (“we’ll all be ruined / rooned”). There is little Australian language for the current global environment – terms of moderation are debased. “Pretty average”, in the Australian vernacular, doesn’t mean average – it means bad. Likewise, “not bad” actually means good. The language reflects the mentality.

Dealing with a modestly positive environment, in which significant risks remain, is an unfamiliar, possibly uncomfortable, situation. Perhaps global investors have now become a little more Australian.

Michael McCarthy is Chief Market Strategist at CMC Markets. He’s writes regularly at the CMC website and you can find him on Twitter: @MMcCarthy_CMC.

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