The February stock swoon in context

Richard shares the BlackRock Investment Institute’s take on this month’s stock swoon.

Global equity markets suffered a sharp reversal in early February after notching a string of record highs. We believe the slide is mainly driven by an unwinding of popular trades betting on low equity volatility. The near-term outlook is highly uncertain, as sentiment shifts can stoke large market swings. Yet we believe investors should take the long view. Our conviction on the upbeat and steady economic outlook suggests the equity pullback is an opportunity to add risk to portfolios, as we write in our BlackRock Bulletin The stock swoon in context.

Leveraged investment products tied to low volatility magnified a downdraft that appeared to stem from investor jitters over the stock market run-up, record equity inflows and rapidly increasing interest rates. These products bet on the VIX, the U.S. equity volatility gauge, falling or staying low. We believe the early February swoon is mostly isolated to equities. The sharp volatility spike has not spread to other assets such as credit or foreign exchange.

BlackRock has long said well-structured exchange traded products can be beneficial to both investors and securities markets – but has raised concerns about inverse and leveraged products designed to move opposite or in a multiple of daily index returns. Traditional exchange traded funds have been repeatedly battle-tested in stressed markets, including the large four-to-eight percentage-point selloffs we saw on February 5. Leveraged and inverse VIX-tracking ETPs did not fare as well during the recent selloff, as my colleague Martin Small noted in his recent post explaining the big difference between plain vanilla ETFs and leveraged or inverse products. BlackRock does not offer the latter.

Periodic outbreaks of higher volatility can happen even within low-volatility market regimes. The sustainability of such a regime does not necessarily imply markets will return to the unusually low volatility levels seen in 2017. A market regime change would typically require a deterioration in the economy and be accompanied by rising macro volatility. We find that equity pull-backs are shorter and recoveries quicker during low macro volatility regimes. That typically makes them buying opportunities.

We see the synchronized global expansion carrying on in 2018. Our BlackRock Growth GPS for G7 economies is holding at its highest levels in three years, with consensus expectations catching up as the expected boost from U.S. fiscal stimulus gets baked into forecasts. Upbeat data are coming in around the world, most recently from China and the eurozone.

The U.S. expansion is on course to become the longest on record, stirring concerns it is about to run out of steam. But is it? The recently enacted tax overhaul and higher federal spending could add 0.8 percentage point to U.S. GDP growth in 2018, we estimate. This could tip the balance toward accelerating growth. Such a boost could shorten the cycle’s expiration date to two or three years. If overheating pressures are contained, the expansion may last longer. We believe this makes for a solid foundation to put money to work in equities, particularly in emerging markets.

Last week, markets appeared to wake up suddenly to one of our core themes for 2018: a modest inflation comeback in the U.S. Strong U.S. jobs and wage data on Friday helped propel 10-year Treasury yields to four-year highs. We see yields rising modestly from here and prefer (repriced) equities over fixed income. Equities are also supported by solid earnings momentum around the world. The market unrest is a reminder that the pace of interest rate increases matters.

Richard Turnill is BlackRock’s global chief investment strategist. He is a regular contributor to The Blog.

Investing involves risks, including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. These risks may be heightened for investments in emerging markets.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2018 and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this post is at the sole discretion of the reader.

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