Crisis on the horizon ‘unlikely’

Harry Colvin, of Longview Economics, says the correction still has a further leg lower, but macroeconomic fundamentals suggest this does not herald a bear market.

Unstoppable bull run stalls

It felt like an unstoppable bull run for equities, with the best January for S&P 500 since 1997, following on from a near 20% gain for the index in 2017. That was of course until bull run stalled. Last week, US stocks posted their worst five-day performance in two years. From peak to trough, the Dow Jones pulled back by more than 12%.

The nervousness hit equity markets around the world, with the Shanghai Composite declining by nearly 14% from high to low. Many indices found themselves in official correction territory (down more than 10% from recent highs).

Volatility returns

Volatility, as measured by the Chicago Board Options Exchange (CBOE) VIX Index, also referred to as the Wall Street ‘fear gauge’, jumped by nearly 116% last Monday, rising to an above-50 reading on Tuesday, a level not seen since the flash crash in August 2015. Short volatility products, for example the XIV ETN, which was popular among some retail investors, blew up as bets on low volatility went radically wrong in a short space of time.

Melt-up again or risk off?

So far this week we have seen a three-day rally for US stocks, clawing back around half of the losses from last week’s sell-off. The question that market participants are left pondering is whether the market melt-up will resume, or if the sell-off is a signal that now is the time to take risk off the table. 

Hold the bear

In this interview, Harry Colvin, Director and Senior Market Strategist at Longview Economics, says a 1987 style crash can never be ruled out, but he is not expecting a large bear market at this point.

In his view, a bear market is normally associated with either a recession or some sort of crisis. Colvin says there is nothing to suggest a disastrous event is on the horizon. In fact, he says the macroeconomic fundamentals are very good. 

Correction has third phase retreat yet to come

Colvin says that normally these pullbacks, those are not related to a recession, play out in three phases. Firstly, there is an initial leg lower, followed by a relief rally, which could last one to two weeks, followed by a final wave of selling in which equities retest or even break below the lows from the first wave. Colvin says it looks as though we are currently in the midst of a stage two relief rally.

IGA, may distribute information/research produced by its respective foreign marketing partners within the IG Group of companies pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the research is distributed in Singapore to a person who is not an Accredited Investor, Expert Investor or an Institutional Investor, IGA accepts legal responsibility for the contents of the report to such persons only to the extent required by law. Singapore recipients should contact IGA at 6390 5118 for matters arising from, or in connection with the information distributed.

This information/research prepared by IGA or IGA Group is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to trade, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. In addition to the disclaimer above, the information does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. Any views and opinions expressed may be changed without an update.

See important Research Disclaimer.