Investors have been feeling nervous so far this year. The US S&P 500, which measures global risk sentiment, rose each month in 2017 and was set to continue its stellar performance. But then everything changed in February.
The Volatility Index of the Chicago Board Options Exchange (VIX), measuring the expected volatility for the S&P 500 and commonly known as the “fear gauge”, broke through the 50 level – the highest since August 2015. The VIX represents the rate and magnitude of changes in prices. A rise in the VIX tends to correlate with a fall in stock markets.
Since then, volatility has remained elevated. Economists attribute this to co-ordinated monetary policy tightening by global central banks and fears of a full-blown trade war between the US and China, as well as its potential to spill further afield.
A top or a healthy correction?
The US S&P 500 fell by more than 10 per cent in February from its peak of 2,872.87. Stocks managed to rebound, but not for long. Despite this, the fundamental economic indicators for the UK, the US and Europe look healthy. Growth continues but at a slower pace than the longer-term average and employment is also on the rise.
What everyone is concerned about is that the monetary policy has been too loose for too long, financial assets are overpriced and inflation is rising faster than was expected. Federal Reserve Chair Jerome Powell is not at all concerned though. He even suggested that inflation was unlikely to spike to 5 per cent like it did in the 1970s.
Will companies continue to outperform?
Tariffs and protectionism benefit no one. Whether they buy raw materials or sell their products overseas, a huge number of firms now operate on a global scale. Protectionism will hamper global growth, which in turn will reduce future earnings.
Some may argue, globalisation is the exact opposite. However, shifting back to domestic production will lead to higher prices and will accelerate monetary policy tightening by central banks across the globe.
What are the chances of a full-blown trade war?
High. Despite US president Donald Trump’s attempt to push for a more level playing field when it comes to global trade, the smallest ‘misguided’ decision could trigger a domino effect of tit-for-tat tariffs. The US will set into motion a 25 per cent tariff on approximately $34 billion’s worth of Chinese goods this Friday, 6 July.
Trade is bilateral and for it to work, it has to benefit both sides.