What are the Triggers for Stock Market Volatility?

While it is near impossible to accurately predict stock market movements, there are warning signs investors can look for which could cause increased volatility

Emma Wall 9 February, 2018 | 9:45AM
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Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by JP Morgan's Tai Hui to talk about stock market volatility.

Hi, Tai.

Tai Hui: Hi. Good morning.

Wall: So, we are officially in correction mode now. Overnight, there have been developments. Can you let me know the situation as of now for global markets?

Hui: Well, I think, what you have seen is that the S&P 500 obviously corrected by 10% since the end of last week and what we have right now is really a market starting to worry on a number of fronts. For example, whether inflation accelerating and therefore, the Federal Reserve has to move more than 3 times they are currently predicting.

And subsequently, we have seen really, I would say, a catchup between the bond market and the equity market where the bond market previously was predicting very slow growth, low inflation. The Equity market was really reflecting strong growth, good earnings. Now, those two views are coming together. I think this coming together is creating all this friction and volatility in the market.

Wall: Because the initial losses were gained again then we've gone down. This volatility pattern, is that the new norm? Should we just be prepared for more of it?

Hui: The latter part is, yes. I think we should have prepared for more going forward, but I wouldn't call this as the new norm. I think it's the old normal coming back. Because if you look at 2017, whether it's in the U.S. equity market or global equity market, it was extremely calm, it was unusually calm.

If you look back to, for example, Asian equities or even U.S. equities, an intra-year drawdown of 10% or 15% is perfectly normal. So, it's obviously very uncomfortable moments for all of us, but I would argue that this is something that equity investors are very much used to.

Again, think back to August 2015 where the equity market again corrected by 11% in over four to five trading days; with the lack of fundamentals reasons, the market does return to a stronger footing. So, I would argue that this is similar environment. It's just that the bond market and the equity market are coming together and that's creating all this volatility. And again, if you look at, for example, the corporate credit market, the foreign exchange market, the level of volatility remains relatively low. So, I would think that this is much of a correction in the equity space rather than the whole financial market telling us that the economy is going in a downward moment.

Wall: Equity markets are almost impossible to predict accurately. However, there are particular triggers that causes volatility. The jobs figures from last Friday from the U.S. looking more positive than expected. Are there particular flags that investors should be looking for that could perhaps signal greater volatility going forward?

Hui: Well, I think, given that inflation is now the name of the game, obviously, inflation data and also the Fed's comments are going to be crucial. In particular, given that we just had the transition of the Fed leadership from Janet Yellen to J Powell, how he communicates with the markets is going to be crucial.

I think the March FOMC meeting is going to be absolutely critical because obviously the market is currently expecting the Fed to raise interest rates by 25 basis points. But on top of that, their dot plots, their economic forecasts I think will tell us a lot more how the Fed views the current environment and their rate projection. And that to me will again be very telling.

Another point to bear in mind is, again, if I just wind back to August 2015, you did have the Fed postponing first rate hikes since the financial crisis from September all the way to December. And the question now becomes if this volatility continues for another few weeks would the Fed adopt the same position, or would they brush that aside and focus on the growth and the inflation picture, I think that again will set the tone for a lot of investors. So, inflation and Fed comments, I think, is crucial.

Wall: Tai, thank you very much.

Hui: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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