History, they say does not necessarily repeat itself, but it does rhyme, according to Mark Twain. All the bricks were in place for a correction, business sentiment indexes, for example, the recent ZEW survey reaching previous peaks and record levels of capital flowed into equity funds. When this extended period of volatility ended it was always going to be painful. Particularly when investment banks develop structured products that allow investors to short volatility at all time lows. When will they learn?
We mentioned last week that Moody’s credit conference also painted a rosy picture of the world. What one can rely on, when there is nothing but blue sky, clouds could be about to appear. One must also remember when the heavens are pouring, the sun does come out to shine again one day. Tax cuts boost the economy they also stoke wage growth which in turn stokes inflation expectations, which in turn spooks the bond market and the circle is complete as equity investors take flight. True that all this is, the fact remains the bond market was as much an excuse as a catalyst. No matter how much one anticipates, prepares dare I say even hopes for the correction ahead of time, the timing never feels great.
The correction in New York on Monday was quick and came towards the end of the day, one can probably lay some of the action at the door of computer-driven trading, though one has no proof of that, it just feels that way. The Vix jumped over 100 pct, the first time its done that, quite a surprise considering what went on in the late 2000’s.
So, what’s the good news, at present credit markets remain stable, yields fell overnight but the curve did not flatten too far. Commodity prices remained stable, also an encouraging sign. Already there is speculation within the financial press that this correction may encourage the likes of the Fed and the ECB to hold fire on tightening monetary policy, Goldilocks porridge is hopefully still just right, for now. We wrote the other day that should yields rise to 3% and put the S&P 500 on a price to earnings multiple of 17x that should equate to the S&P 500 correcting about 10%, after Monday’s fall we have got close to there. We have several speeches from Fed members this week not to mention the bank of England meeting on Thursday. The possibility is that we may not be out of the woods for a few days yet.