Capitulation the name of the game

Equity markets around the globe on Thursday continued to focus on the potential for growth to slow next year. The latest catalyst appeared to be the arrest of a Huawei top executive in Canada on the orders of the US. This act reignited fears of an escalation in trade wars between the two superpowers. The selloff has been dramatic as global indexes fell between 2-3% during the day. The FTSE 100 has fallen 15% from its high earlier in the year, Germany even worse, 20%. Quite a correction.

If one takes a dispassionate view of today’s correction it often helps to look at how other asset classes are performing, as it can provide a clue as to whether we are reaching panic mode.  The Vix index has risen but remains close to its long-term average. This could yet suggest we have not reached the point of capitulation and equity markets could have further to go, or it could mean investors remain confident in this being an overdue correction.  The yen has been rising against the dollar, however, it did not appear to rise dramatically again on Thursday. The Russell 2000 index outperformed the S&P 500, as did consumer discretion over staples. There was quite a move for defensive assets as the yields on US Treasuries fell sharply. The oil price continues to fall as OPEC meeting.

Jerome Powell the Federal Reserve chairman spoke at the Economic Club of New York on Thursday regarding the financial stability of the US economy, right in the heart of the days market volatility. Jerome Powell started pointing out how financial stability has improved since the crisis of 2007, particularly within the banking system. Leverage, as interest rates rise and economies slow, is often the cause of a market correction, Jerome Powell expressed the view that he believes there is not excessive leverage at this time. Overall, he tried to paint a reassuring picture on the financial stability of the economy.

This recent correction has led to capital markets reducing the probability the rate the Fed will raise interest rates in the coming year. When questioned on monetary policy he appeared evasive. Equity markets need a point of capitulation to recover from, they fall at the point of maximum optimism and rise at the point of maximum pain. Have equity investors started to capitulate into the year-end, giving up on the hope of a yuletide rally? It is quite possible as traders will be focussing on Christmas, some will have had a better year than others. Those with a good year will be happy to cut losses, those who have not had such a good time will throw in the towel and hope for better next year. If we are not at the point of capitulation, we are at least closer.

Posted on December 6, 2018 .