How is the industry reacting to the current volatility of the financial markets?

The rising tensions between Russia and other nations over Ukraine, a continued hiking inflation at a pace which we haven't experienced since the late 1980s and early 1990s, and the reaction of the central banks, as well as a marked slowdown in China, and the effects of Omicron, have created at atmosphere of volatility in the markets.

Under this situation of uncertainty and instability, we have received some insights from professionals within the asset management industry who analyse the current scenario of volatility that the markets are experiencing.

Jon Maier, CFO and Morgane Delledonne, Director of Research at Global X ETFs

The VIX index is above 30 as risky assets dropped, safe haven assets like gold rose, yields on US Treasuries are marginally lower, and Swiss Franc appreciated to its highest level against the euro in over six years. The risk off sentiment seems driven by a combination of events.

First, inflationary pressures in the U.S. are weighing on real income and in turn on demand with retail sales ex-auto and gas contracting 2.5% in December. There is some risk that the rate increases from the Fed could dampen demand and cause the U.S. economy to go into a recession by aggravating the demand shock. 

Second, the global impact of omicron. Companies are citing worsening labor and supply chain concerns with COVID case spikes, workers out sick and trucker shortages. In certain environments, this could lead to increasing supply constraints and inflationary pressures. A positive spin on this could be potentially declining demand through equity destruction, the supply chain issues may somewhat be offset by potential demand destruction and help ease inflation sooner than anticipated.

Third, the marked slowdown in China could contribute to dampen global supply as well but as I just mentioned it could also be somewhat offset by potential demand destruction to help cool inflation.

Last, rising tensions between Russia and other nations over Ukraine could prolong Europe’s energy crisis and add economic risk to the region. The impact on the Energy market and the unknown is spooking markets.

About 1/3 of the S&P companies are reporting Q4 earnings this week. Depending on how earnings go, growth stocks with weak fundamentals could further sell off in the current environment. On the other hand, earnings from cyclical companies will give us better reads on Omicron’s impact, wage pressures, supply chain issues, demand pressures, and China.

On the European front, so far this year euro stocks have been more resilient than U.S. stocks thanks to more attractive valuations in particular in France and Italy. However, Eurozone PMIs edged lower in January for the second month in a row and is now almost 8 points lower than its peak in July last year. European economies benefit from lower rates than their U.S. counterparts which translates to lower valuations, although the persistently high energy costs and the new geopolitical uncertainty in the region could dampen sentiment in the near term.

In the current macro backdrop, typical of late business cycle, we believe the most vulnerable growth companies are those with weaker balance sheets reliant on the whims of the capital markets. Market participants are more selective with a focus on valuations, fundamentals, and quality. Margins are expected to remain a key focal area as we wait for more earning updates this week.

With that, in our outlook piece, we indicated that the market will pay closer attention to fundamentals and be more selective heading into 2022 and clearly they currently are.

Susannah Streeter, senior investment and markets analyst, Hargreaves Lansdown

The unease seeping across financial markets is fast turning into panic as the fear factor over conflict in Ukraine intensifies while the spectre of soaring inflation looms ever larger. The FTSE 100 sank deeper into the red with losses intensifying after Wall Street opened to yet another slide. Once again tech stocks are taking the biggest tumble on indices with chip maker Nvidia,Tesla and Netflix among the biggest fallers on the S&P 500 which has entered correction territory today. Investors are bracing themselves for action following tough talk from the US Federal Reserve at a key meeting this week. There are increasing signals that it’ll reign in stimulus and push up rates more rapidly, lowering the liquidity in financial markets which had led to exuberant valuations.

The rising threat being posed by Russia as talks have disintegrated is now adding to a loss of investor confidence across the board. As many parts of the world still grapple with the wrecking effect Omicron is having on economies, there are now worries that a conflict on the fringes of Europe could upset the longer term recovery.

The announcement testing requirements would be lifted for travellers to the UK didn’t touch the sides of airline stocks, which have been caught in the downward spiral of stocks. The end of tests for double vaccinated arrivals had been trailed by the British government last week and so expectations that bookings would rise for the spring/summer period had already been priced in. Now the concern is that if conflict breaks out, or at the very least a stand-off continues for many weeks to come, confidence among the travelling public could take a fresh knock, and would prove to be yet another set-back to a long haul recovery for the airline industry. British Airways owner International Consolidated Airline Group has hit another bout of turbulence plunging by more than 6%, while Rolls Royce, so highly reliant on the commercial airline sector, fell by more than 5%.

House builders are vulnerable to rising interest rates and that nervousness is seeping through the sector today with Barratt Developments down 8% and Berkeley Group falling by 6%. Demand for mortgages is expected to continue to wane especially as the cost of living squeeze intensifies. Investors clearly worry that house builders, who have been enjoying the cheap loan party and pent-up demand over the past year, are facing a difficult trajectory with a rapidly cooling housing market now on the cards.

Crypto fans, lulled into a false sense of security amid sharp price rises during the pandemic are now facing a rude awakening with assets plunging across the board with Bitcoin and Ether falling by around 7% today. Crypto coins and tokens have been shown to be highly sensitive to equity prices, propelled upwards on a wave of cheap and easy money. Hopes that Bitcoin would act as an inflation hedge have fast evaporated, losing more than half its value since its November high, as consumer prices have soared. There may be speculators waiting in the wings to buy the big dip, but expect the volatility to continue as money liquidity washing around financial markets evaporates.

James Athey, Investment Director, abrdn

The most recent historical analogy for what markets are currently experiencing is the year 2018. That was the year that Jerome Powell’s Fed was hiking rates and reducing its balance sheet, and the result was a painful year for all asset classes. Bond yields rose and equity prices fell. The only place to hide that year was in cash.

This year has the potential to be even more disruptive. Prevailing equity valuations, particularly in the US, have been considerably higher than those which prevailed in 2018. The year-over-year changes in fiscal policy and liquidity are set to be considerable headwinds to cyclical activity and sentiment. Most importantly of all – inflation is running at a pace that we haven’t experienced since the late 1980s and early 1990s. The reality is that recent economic recessions and financial market volatility and weakness have all been treated with the catch-all cure of monetary easing. That’s been permissible only because inflation has been so quiescent.

The situation central bankers today face is vastly different. They must countenance the idea of more aggressive monetary tightening in spite of potentially falling growth and inflation momentum. They must get ahead of the curve to prevent expectations becoming de-anchored, and thus, solidifying the potential for incredibly damaging price and wage spirals. The policy path of least regret is, for the first time in a generation, to deal with higher inflation and inflation expectations now and worry about the consequences for growth and financial market stability later. This is a world that most investors have never experienced and it is likely to lead to significant asset allocation shifts driving volatility and asset price weakness periodically throughout this year.

Salvatore Bruno, CIO of Generali Investments Partners

Volatility has been triggered by inflation developments from one side and by the reaction of some central banks from another side. On top of this, the new Covid wave increased the potential downside risk of risky asset, although it seems to be much less severe compared with previous waves.

Inflation became increasingly less temporary than expected, with more permanent components that started to move substantially higher and more pressures from supply-chain factors.

The FED changed its view moving quickly to a hawkish tone starting to talk about quantitative tightening that fueled further volatility. Yields will probably continue to rise, after some consolidation, with the US curve that will continue to be flat, until a quantitative tightening starts, while the European curve will probably continue to steep. This would still favor value vs growth sectors on the equity side, assuming a positive earnings cycle.

Main risks are a de-anchoring of inflation expectations, that would trigger a more hawkish FED, a lower than expected growth and geopolitical tensions. With the Covid still in the background. 

Martyn Hole, Equity Investment Director at Capital Group

Fears of persistent inflation, tightening monetary policy and rising bond yields have caused nervous investors to exit growth stocks since the start of the year. More richly valued sectors like tech have suffered the brunt of the sell-off, as their valuations come under closer scrutiny with the expectation of higher interest rates. The Nasdaq Composite fell 7.6% last week, suffering its biggest decline since the start of the pandemic and extending its year-to-date loss to -12.5%.

It is warranted for investors to be cautious of valuation levels, especially at market peaks, however, they should not be afraid of highly valued companies and completely avoid them, as history has shown that many high multiple companies could continue to appreciate as long as fundamentals come in above expectations over time.

Starting valuations seem to matter less over the long term, and some companies are expensive for good reasons. We focus on deep fundamental research to find long-term winners with underappreciated potential, even if they have higher valuations, because we understand that often the valuation becomes much more justified over longer time horizons. This is especially true for secular growth companies that have large and expanding total addressable markets combined with low penetration rates, giving rise to potentially very long revenue and earnings growth runways. Therefore, focussing on company fundamentals will bring clarity amidst short-term volatility and help identify long-term winners.