Summertime blues or sign of things to come?

A VIX index reading of 17.6 compares to a post-1990 average of 19.3, so the so-called ‘fear index,’ which measures expectations for future market volatility, is hardly blaring out a warning signal.




The VIX – or ‘fear’ – index has crept higher during 2018

Source: Thomson Reuters Datastream

However, the indicator stood at just 9.2, almost a record low, on 3 January, as optimism about the Trump tax cuts, accommodative central bank policy and hopes for a globally synchronised economic recovery took many stock markets to new peaks.

Since then, fear has crept steadily back into markets and the going has got tougher. Analysis of total returns from key asset classes, continents and sectors, in sterling terms over the first six months of 2018, offers some potentially surprising trends.

This column would pick out three in particular:

  1. Equities and commodities may still believe in the inflationary, globally synchronised recovery but bond markets appear less convinced, especially if price action in the very long end of the market is any guide. At least one of them has to be wrong, in the end.
  2. Emerging markets are taking a pounding, in terms of their currencies, bonds and equities and high yield bonds are making heavier weather of it. This could smell of gathering risk aversion, especially after the hammering given out to cryptocurrencies and low-volatility strategies earlier in the year, to suggest money may be slowly starting to retreat from riskier, ‘peripheral’ markets to ‘core’ ones that are seen as safer propositions.
  3. This shift could help to explain the ongoing strong performance of technology stocks on a global basis, as these firms are seen as largely immune from many of the geopolitical and economic questions which dominate today, owing to their dominant market positions. Advisers and clients must nevertheless still consider the issue of valuation and the dangers of paying any price for safety. After all, the more expensive an asset class becomes, by dint of its popularity, the more dangerous it becomes, as the experiences of the tech collapse of 2000-2003 and the fall from grace of the Nifty Fifty in 1973-74 imply.

None of this is to say advisers and clients should begin to panic. These shifts in sentiment may be no more than a case of the summertime blues which will wash away as soon as we get to St. Leger Day in September. Central bank policy also remains a key variable.

But it can be argued that the mood music is changing and while the market cannot always be right – it would be pretty hard for anyone to make capital gains if it were – its views should always be respected.

Performance breakdown

A swift analysis of five performance data charts helps to draw out the three themes above. In each case, the graphics show total returns in sterling terms and as such the pound’s second-quarter swoon helps to boost the figures offered by overseas markets. This is in itself a further issue to ponder with the future in mind.

The first chart shows how inflation and recovery were the dominant themes of the first half, especially early on. Commodities and stocks beat bonds.

Bonds underperformed in H1 to suggest faith in a strong economic upturn …

Source: Thomson Reuters Datastream

Yet the bond markets’ returns had an unusual slant to them. Longer-term Government bonds did best (although yen strength against the pound could tilt the figures), high yield struggled, corporate bonds did poorly and emerging market fixed-income markets were flayed.

The strong showing by longer-term paper suggests fixed-income markets feel central banks may not raise rates as much as some think – or even if they do, a swift capitulation and return to rate-cutting and Quantitative Easing will follow, meaning that headline borrowing costs do indeed prove to be ‘lower for longer.’

… but fixed-income markets seem less convinced

Source: Thomson Reuters Datastream

If emerging market bonds hardly covered themselves in glory, their equity counterparts did even worse, moving swiftly from penthouse to outhouse, as they went from being 2017’s star performers (and the consensus pick for 2018) to notable laggards.

Currencies will have had a role to play here, even relative to an enfeebled pound, as Brazil, Turkey, South Africa and China all saw the counters weaken – and that is before the rout in Argentina is taken into account. Weakness in the Russian rouble and the Czech koruna (despite a run of four rate rises from the central bank) also caught the eye.

A booming US economy was not enough to lift all boats, particularly given fears over the rise of global protectionism, a particular concern for emerging markets.

US stocks did best in H1 …

Source: Thomson Reuters Datastream

America’s economic and market might can also be seen in the global equity sector data and Technology’s dominance of the sector listings.

… with Technology as the best sector and financials and telecoms the worst ones

Source: Thomson Reuters Datastream

Energy stocks fed off a firm oil price. But neither industrials nor miners (Materials) nor financials made any headway, which looked odd in the context of broader bullish sentiment.

The failure of the financials in particular is a concern and their slump in the second quarter needs to be followed as it was their boom, bust and then recovery which have largely set the tone for global markets since 2003.

AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.