Equity markets seemed to take a ride on a rollercoaster this week. Even though the moves in recent days are overdone, increased market volatility is likely to be here to stay for quite some time.
Triggered by renewed worries about China, global equity markets came under significant pressure during the past week. Indicators of market volatility spiked to levels that aren’t seen too often. Although the current spike is overdone, this probably signals the end of several years of fairly modest volatility. Since early 2012 market volatility had been subdued, at least in part thanks to monetary policy. Two factors are likely to force a change in that relative tranquility in coming quarters:
- China: the Chinese economy has been slowing down for several years now, and this will continue in coming years. Up until now this economic slowdown has been managed with some success by the Chinese authorities. New monetary stimulus measures announced earlier this week suggest the authorities will continue to try to control the pace of the slowdown. Nevertheless, concerns about China are likely to flare up regularly in coming years as the transition process of the Chinese economy progresses.
- The beginning of the end of the era of ‘free money’: for the past seven years the world has seen unprecedented monetary stimulus with policy rates at zero and massive quantitative easing programs. The time for a change in the direction of monetary policy is approaching. Even if it now seems likely that the Fed will hold off somewhat longer on its much anticipated first rate hike, by the end of this year the first step towards a gradual normalisation of monetary policy is likely to have been taken in the US and the UK. In the past, such a turn in monetary policy has always generated volatility in financial markets. This time will not be different.
Spikes in volatility create opportunities in financial markets. In coming months, such opportunities will be there. That said, investors will have to be prepared for a rougher ride.