It’s happened at last.
Stock markets are selling off sharply.
As I write, the FTSE 100 index is down about 2% today. That takes the fall from the mid-January to around 7.5%.
It also wipes out all the UK market’s gains over the last 12 months.
So is this finally the big one – the major pullback that I’ve been expecting for a while? Or is it just market ‘noise’?
Forewarned is forearmed
Casting round the media today, I’ve seen a number of articles that have tried to explain why stock markets have gone down over the last few days.
If you’re a regular reader of my DR column, you’ll already know most of the answers.
For the last six months or more, I’ve been suggesting that shares had become very pricey and that an equity market drop was on the way. Like here in December, in January and this from last week. So I won’t repeat all the reasons today, except to say that recent rises in bond yields had made stocks even less appealing.
The key question for investors now is: what happens next?
And that’s still a tough one.
Trying to forecast exactly how financial markets are going to move over the short term is always fraught with difficulty.
There are so many moving parts. And these days, so much more trading is driven by computers rather than by real people making real decisions.
So the short answer is: I can’t tell you where share prices will be this time next week. And nor can anyone else.
But one thing is clear. Volatility is back.
Watch the Vix
When shares rise in a near-straight line like they have on Wall Street in recent years, they become less volatile.
US markets measure volatility by the VIX index, which again I wrote about in DR last October. Traders call the VIX the market’s ‘fear gauge’.
The less concern there is – and the greater the level of complacency – the more the VIX drops. When investors start getting worried once more, up it shoots again.
As you can see from this chart (for which thanks to Markets Insider)…the VIX has gone nuts!
It has soared from around 13 to above 45 in February alone.
Now the VIX is very technical. And if you start delving into the details – and you’re not a fully-qualified mathematician – it can get very baffling. I freely admit that I find some aspects hard to understand fully.
There’s a very simple message here, though.
Investor complacency has now been shattered. As traders say: Large!
For what it’s worth, I’m not convinced that the current sell-off will immediately develop into a full–scale financial crisis. Whereas the correction was more than overdue, equities may yet recover again.
In response to the stock market’s falls, yields on bonds have now eased, thus making the latter less attractive investments than they were last week.
But this sell-off feels like more than just market ‘noise’. We’ve all been reminded, loud and clear, that shares don’t defy gravity for ever.
Some people will be tempted to buy into the market after the latest falls. While that could prove a good trade, it could also be like catching a falling knife.
I still believe that, over time, the prices of many stocks could fall much further. Even if they don’t, potential returns over the next few years are likely to be paltry at best. This is not the time to take greater chances with your hard-earned money.
So keep a close eye on Wall Street – and the VIX. Be aware of where the downside risk exists within your portfolio. And keep your gold as a safe haven – in case another financial crisis does now develop.