Rising volatility for investment markets in February

After a strong start to the year, global stock markets were sold off in early February on the back of a stronger-than-expected wage growth figure in the US, which alarmed markets.

Good news sends markets into spin

It might seem counter-intuitive that good economic news would trigger a share market fall but markets suddenly became worried that the US the economy, boosted by the Trump Administration’s tax cuts, was overheating – which could force the Federal Reserve’s hand on the trajectory of interest-rate rises.

What appeared to spark the fall was news that the average hourly earnings in the US was up 2.9% for the 12 months to January, much higher than expected, which stoked the fears of rising inflation. The US markets responded with a week of falls, including two 1,000-point plunges for the Dow Jones Industrial Average: one of which, a 1,178-point slump, was the Dow’s biggest one-day point drop in history (although, putting that number in perspective, at 4.6%, it did not even make the Dow’s Top 25 daily percentage losses.)

The Dow Jones plunged more than 3,200 points, or 12%, in just two weeks, and US Treasury bond yields surged to a four-year high, at 2.93%, as a stronger-than-expected US inflation figure for January – the core Consumer Price Index (CPI) figure rose by 0.3%, its biggest rise in a year – seemed to confirm the ‘inflation break-out story’.

Share market volatility spiked – albeit from the historically low levels that prevailed in 2017 – and the consequent turmoil in complex derivatives based on the Volatility Index (VIX – the so-called “short volatility” trade – magnified the fear, contributing to the correction.

But from mid-month, the US markets rebounded, at one point recovering about three-quarters of its losses. February ended as dramatically as it began, with the Dow Jones dropping 680 points during the month's final two days, leaving it down about 1,600 points from the record high in late January.

In the wash-up, both the Dow Jones and the broader S&P 500 had their worst month in two years. The Dow Jones ended February down 4%, the S&P 500 index fell by 3.7% while the technology-heavy Nasdaq Composite Index fared slightly better, shedding 1.7% for the month. As the month ended, the Conference Board’s monthly report showed US consumer confidence surging in February, reaching its highest level since 2000.

Strong economy no protection for European stocks

European markets followed their US counterparts lower in the first half of February, bouncing back later in the month. Germany’s DAX index lost 5.7%, the CAC 40 in Paris fell 2.9% and the Euro Stoxx 600 index shed 3.8% on a total-return basis. The UK’s FT-100 index was down 4%.

February saw data showing that the Eurozone economy grew by 2.5% in 2017, mainly driven by strong performances from Germany, Spain and France. Germany added 22,000 new jobs in February, with the unemployment rate holding steady at 5.4% – the lowest since German reunification in 1990. The French economy grew by a faster-than-expected 2% in 2017 – almost doubling the 1.1% growth recorded in 2016 – as investment and output picked up in the fourth quarter, according to the national statistics agency INSEE. At the end of 2017, France’s unemployment rate stood at 8.9%, its lowest level since 2009. The UK lagged the Eurozone, with its gross domestic product (GDP) growing by 1.8% in 2017, the slowest pace since 2012.

Asia joins in market malaise

The stock market sell-off also flowed into Asia, where Japan’s Nikkei index lost 4.4%, Hong Kong’s Hang Seng index shed 6.2%, the KOSPI in South Korea gave up 5.4% and the Shanghai Composite index lost 6.4%.

China reported an official February manufacturing purchasing managers’ index (PMI) figure that hit a 19-month low of 50.3, while staying in expansion territory (a reading above 50 indicates expansion, while a reading below that signals contraction.) The private Caixin/Markit manufacturing PMI – which focuses on small and mid-sized businesses – was much stronger, hitting a six-month high at a stronger-then-expected reading of 51.6 for February. Further good news for the Chinese economy came with its consumers spending more than ever during the Lunar New Year holiday (February 15–21): according to China’s Ministry of Commerce, Chinese consumers spent US$146 billion ($188 billion) in the period, up 10.2% on a year ago.

Japan’s February manufacturing PMI came in at a seasonally adjusted 54.1, down from January’s 54.8, which was the strongest reading in almost four years but job hiring rose at the fastest pace in 11 years, with employers optimistic on future demand.

In Australia, against the headwind of the global market falls, the S&P/ASX 200 Accumulation index managed a 0.4% rise for February. This results was also helped by expected solid company profit results and aided by the Australian dollar shedding 3.6% against the US currency in February, closing the month at 77.62 US cents.

On the commodities front, iron ore gained 7.4%, Australian thermal (electricity) coal was down 0.1% and coking (steelmaking) coal was flat for the month. Gold was down 2% in US$ terms, while Brent crude oil lost 4.7% and West Texas Intermediate crude eased 4.8%.

Disclaimer

Information current as at 28 February 2018. This article provides an overview or summary only and it should not be considered a comprehensive statement on any matter or relied upon as such. This information does not take into account your personal objectives, financial situation or needs and so you should consider its appropriateness, having regard to your personal objectives, financial situation and needs having regard to these factors before acting on it. Past performance is not a reliable indicator of future performance. This article may contain material provided by third parties derived from sources believed to be accurate at its issue date. While such material is published with necessary permission, no company in the Westpac Group accepts any responsibility for the accuracy or completeness of, or endorses any such material. Except where contrary to law, we intend by this notice to exclude liability for this material.