Putting Equity-Market Turbulence into Context

Many equity investors were no doubt happy to put 2018 in the rear-view mirror. The heightened volatility in the fourth quarter of the year in particular took many investors by surprise—but what is often missing in the discussions about the volatility is that it didn’t stem from a broad deterioration in economic fundamentals, according to Ed Perks, CIO, Franklin Templeton Multi-Asset Solutions. And, he notes investors had become so used to low levels of volatility that 2018 actually marked a return to “normal levels.”

News headlines and market commentary have been overwhelmed by discussions about the notable increase in market volatility, especially over the last several months of 2018. But we must remember that in 2017, volatility was exceptionally low. In our view, 2018 marked a return to more normal levels.

Nevertheless, we currently do not see any systemic deterioration in the market fundamentals. As such, recent market action is very different from the previous major selloffs, including that of 2008.

The recent return of “normal” volatility is not surprising given factors including fear of a slowing economy, US-China trade tensions, political uncertainty and market trading dynamics. Among these, political uncertainty, including the recent US government shutdown, should not be underestimated when it comes to volatility in the markets.

Even absent a true financial impact, the uncertainty and resulting investor sentiment can create headwinds for the financial markets. At issue is how functional the divided US government will be over the next two years and whether it can effectively handle an unexpected crisis.

Additionally, the increased influence of computerized trading and quant models that trade based on data patterns versus company fundamentals likely created especially exaggerated market moves at the end of 2018, which made December an extreme outlier compared to “normal” volatility.