A summer of intense volatility

During the third quarter of the year which came to an end last Friday, some truly extraordinary events took place which led to a significant degree of volatility across various asset classes amid continued historically high inflation readings, rising interest rates and recession fears.

The three main US equity benchmark indices have now declined for three consecutive quarters for the first time in many years. The S&P 500 index, for example, last declined for three successive quarters at the time of the start of the global financial crisis between 2008 and early 2009.

With all three US indices now well into bear market territory after a particularly weak performance during the month of September and with year-to-date declines of well over 20 per cent, few may recall the significant rally across equities between mid-June and mid-August with the S&P 500 index jumping by 17 per cent and the Nasdaq index surging by 23 per cent. The extent of the rally at the start of the summer period had many commentators claiming that this marked the start of a fresh bull market cycle.

However, as the Federal Reserve and other central banks continued their monetary policy tightening measures to tame the worst inflation experienced in several decades, yields across the US Treasury markets and other sovereign bond markets jumped to their highest levels in more than a decade and equity markets quickly reversed the summer rally dropping to fresh lows for the year. For example, the release of US inflation data in mid-September triggered the largest daily decline in equities since June 2020 as the S&P 500 lost 4.3 per cent and the Nasdaq tumbled 5.2 per cent.

On the other hand, last week, the yield on the 10-year US Treasury note rose above four per cent for the first time since 2010 after starting the third quarter of the year at just under three per cent implying a significant decline in bond prices. This was reflected across most bond markets with similar spectacular moves also in the eurozone and UK.  Naturally, the Maltese bond market mirrored the downturn seen across the eurozone with prices of Malta Government Stocks declining rapidly as yields surged. In fact, the Treasury of Malta last week announced the issue of new Malta Government Stocks with the 10-year yield at just under the four per cent level last week – its highest level in several years and significantly higher than the 0.75 per cent level at the end of 2021.

The currency markets continued to be dominated by the soaring value of the US Dollar especially against the Japanese Yen and the British Pound which are on course for their biggest yearly declines in many years. Japan intervened in the currency markets for the first time since 1998 as the Yen has so far plunged by 20 per cent this year against the US Dollar (the weakest performance since 1979). By the end of the quarter, the British Pound had declined by almost 18 per cent against the US Dollar (the weakest performance since 2008). Sterling’s decline accelerated in recent weeks following the major announcement by the new Chancellor of the Exchequer of a series of tax cuts amounting to GBP45 billion in order to try to stimulate growth. The British Pound partially recovered from the all-time low against the US Dollar at the start of the week after the Bank of England intervened by announcing that it would temporarily buy more UK gilts.

Following the bleak performance for equity markets during the past nine months, many financial market commentators believe that the aggressive monetary tightening policies by the major central banks together with the ongoing geopolitical uncertainty could continue to weigh negatively on equity markets. The turbulence is therefore very likely to continue until there is evidence that the central banks are winning their battle against inflation thereby allowing policymakers to eventually end monetary tightening measures. The upcoming reporting season commencing in the US in the next few weeks is likely to be a key determinant of investor sentiment during the fourth quarter of the year as market participants assess the negative impact of the strength of the US Dollar and the high inflation on margins.

Although there is further downside risk for the equity markets in the near term, a new bull market cycle will eventually emerge. It is interesting to note that since 1950, the average bear market has lasted 391 days with an average drawdown of 35.6 per cent. The current bear market has so far lasted 269 days with a decline from peak-to-trough of about 25 per cent. In the midst of this very challenging environment, several investors may question the catalysts required to support a new bull market. A number of financial market commentators seem to agree that the two main factors that are likely to lead to improved investor sentiment are a sustained decline in inflation levels which would then allow central banks to pause their series of rate hikes.

Essentially, every cloud has a silver lining and in current circumstances, investors that are able to withstand periods of volatility and have a high-risk tolerance could view the remaining period of the bear market as a time to acquire shares of fundamentally strong companies at much more advantageous valuation levels.

Read more of Mr Rizzo’s insights at Rizzo Farrugia (Stockbrokers)

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