Stocks halt their rout as Bulls come charging back
A strong recovery in US stock markets after the European close last night has caused at least a temporary end to the global rout on equities which saw trillions wiped off valuations in a frantic start to the month. Today the FTSE 100 is looking to recoup some of its losses and is higher by around 45 points at the time of writing. The pound is little changed against most of its peers ahead of 'Super' Thursday apart from the yen with the Japanese currency making strong gains across the board on its perceived low valuation as well as its safe-haven characteristics.
US stocks make largest gains in 2 years
The day after posting its largest ever single-day decline, the Dow experienced a strong bounce with the market recording its largest daily gain in 2 years after rallying more than 500 points. To put these moves in some perspective whilst the benchmark remains firmly lower on the week and 8% below it record peak posted at the end of last month it is also still around the levels seen in mid-December which, at the time were all-time highs. The market remains in an uptrend according to the 200 day moving average and as long as the lows from Monday remain intact then there could well be further ground recovered going forward.
Increase in volatility could reduce chance of further sharp drops
Given the lack of a strong fundamental catalyst for the abrupt declines and a strong global economic backdrop it appears unlikely that we are on the verge of a significant correction in the region of 20% or more - a common definition of a bear market. What is far more likely to occur going forward is a sustained pick-up in volatility, which after a prolonged absence has made a dramatic reappearance of late and this is probably a good thing.
Given the stretched valuations in US stocks (they have only been more expensive on 2 prior occasions) a pullback was seen by many as being healthy in a longer term bull market, the problems arose in the nature of the declines and the almost unprecedented spike in volatility from all-time lows. Monday’s move in stocks saw the volatility of volatility hit an all-time high in what is a clear indication that markets were drastically underestimating price swings and had been lulled into a false sense of security.
Looking ahead it is unlikely traders will be so complacent and therefore recent drops will likely have served as a timely wake-up call to those that believed the ultra-low volatility environment was here to stay. In approaching nearly a decade, the global stock market rally is certainly long in the tooth by historical standards, but it appears unlikely that the recent drop will signal the beginning of its demise; rather the declines have simply let a little air out of over inflated valuations - albeit in a fairly dramatic fashion - and for the time being at least, the outlook going forward remains favourable for equities.