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Macroscope | US stocks are booming, volatility has collapsed and the Fed is dovish. Why do investors remain cautious?
- Major asset classes have bounced back this year with the S&P 500 gaining 25 per cent from its low in December. However, equity funds in developed economies continue to suffer outflows, with global growth prospects, especially China, remaining a concern
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At the end of last year, global equity markets were a sea of red. Following a brutal sell-off that began in early October, stocks in both developed and developing economies finished the year deep in negative territory, with emerging market shares suffering double-digit price declines.
Yet since Christmas Eve, the benchmark S&P 500 index has shot up nearly 25 per cent. On Tuesday, the index surpassed its previous closing high, from September 20, 2018. Other major asset classes, which also suffered steep falls last year, have recovered just as dramatically, with spreads on corporate debt – in particular high-yield, or “junk”, bonds – narrowing sharply and commodities roaring back from their end-of-year rout.
Indeed, the biggest casualty in markets this year has been volatility, the main beneficiary of last year’s turmoil. The widely followed VIX Index – Wall Street’s “fear gauge”, which measures the anticipated volatility in the S&P 500 – has plunged 63 per cent since last Christmas to 13.1, only slightly above its historic lows at the end of 2017. What is more, other key gauges of volatility, notably in the US government bond market as well as in currency markets, are also subdued.
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The speed at which volatility has collapsed is striking given the plethora of risks investors are facing, ranging from the slowdown in global growth to the deeply strained relations between the US and China, whatever the outcome of the current trade talks. The ferocious rally in US equities is even more remarkable given the downward pressure on S&P 500 companies’ earnings, which may have contracted in the first quarter of this year, their first year-on-year decline since 2016.
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The single most important factor in explaining the renewed calm in markets is the abrupt decision by the Federal Reserve in January to take a patient approach to determining the future path of interest rates, reversing an earlier hawkish stance that had spooked investors.
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