As the Nasdaq endures its longest string of daily losses since November 2016, and with other stock indexes also under pressure, there is a notable sense of unease among investors who believed until recently that selloffs were very limited in duration, of small magnitude, and quickly reversible.
Now, markets suddenly seem less confident about their ability to shrug off political factors.
They also appear more vulnerable to contagion from company-specific news such as Facebook’s apparent entanglement in questionable political-messaging practices.
There are also significant realignments that result in these 10 issues:
- After an unusually long period of effective volatility repression, markets are transitioning to an operating regime that involves more “normal” (that is, higher) levels of both realized and implied volatility.
- The resetting of the volatility paradigm, the first of three ongoing transitions, naturally leads to the repricing of a broad range of other asset classes. Stocks with the widest common ownership and/or elevated valuations are particularly vulnerable, as are those that lack a deep, dedicated investor base.
- Single-company stories such as Facebook's can add to the unease when they are seen as a potential indication of a broader issue -- in this case, the growing risk of a government and societal backlash against systemically important big tech.
- This market reset is vulnerable to technical amplification, particularly because of “crowded trades” in tech and credit, along with the overpromising of liquidity associated with the recent proliferation of certain exchange-traded funds and the extent to which some investors have overstretched in pursuit of returns.
- All this coincides and interacts with two other major transitions. The first is policy-related and has to do with the central banking community’s gradual and measured exit from prolonged reliance on unconventional measures. The second involves the current synchronized pickup in global growth that offers the advanced economies in particular the best chance since the global financial crisis of ending too many years of too-low and insufficiently inclusive growth.
- Beyond the short-term influences and market technicals, the success of these three major transitions -- in market, policy and economic regimes -- will determine the well-being of investors, including the speed, orderliness and ultimate destination of the repricing of their financial assets.
- The Federal Reserve is expected to continue on the path of policy normalization, which means this important central bank is gradually getting out of the business of de facto suppression of market volatility. It is also becoming clear that other systemically important institutions, such as the Bank of Japan and the European Central Bank, are likely to follow suit later this year.
- Meanwhile, the markets’ faith in the economic transition to an environment of higher and more inclusive global growth is being shaken by more frequent talk of trade wars. Such concern among investors can endanger the durable success of the pro-growth policies that have been implemented in the U.S., the natural economic healing process (not only in Europe and Japan, but also in Brazil and Russia), and the scope for further pro-growth policies such as infrastructure spending in the U.S. and around the world.
- What appears to be shaken market confidence in the many beneficial consequences of a durable synchronized pickup in global growth has been amplified by the materialization of some issues (such as higher yields, dollar appreciation and protectionist measures) that failed to appear last year.
- This has naturally dampened a seemingly overwhelming investor conditioning to buy the dip, regardless of its causes, accentuating asset price volatility and making the market gyrations more pronounced and less unidirectional over the longer-term.
As long as global growth continues to rise in a sustainable and more inclusive fashion, sounder fundamentals would help anchor the long-awaited market transition away from liquidity support and toward stronger economic and corporate underpinnings. And while this would carry the hope of a sounder medium-term footing for markets, it does not imply a return to the abnormally low volatility of last year.
The two-way price volatility of recent weeks, which was in sharp contrast to the relatively long period of calm that preceded it, is a better indication of what lies ahead. Fortunately, there are observable market-based variables that can be monitored on a high-frequency basis to shed light on the probability of success.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He was chairman of the president's Global Development Council, CEO and president of Harvard Management Company, managing director at Salomon Smith Barney and deputy director of the IMF. His books include "The Only Game in Town" and "When Markets Collide."
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