Market commentary: Volatility is not necessarily the enemy

China seems to have taken up the role of the prima donna of the summer, becoming the primary driver for volatility in equities and credit markets around the globe. The world second largest economy took the spotlight in mid-June when its stock market spiraled down in bear territory after falling almost 30% in three weeks. 

The following month, China returned to spook global markets on rising concerns that its economy is slowing down more than expected and more than the Government is willing to acknowledge.

Finally, in August, the Chinese Central Bank decided to suddenly liberalise its currency, which resulted in a panic selloff across the board that has rattled global equities for almost a week. The latest plunge in the equity and credit markets has prompted the Chinese Central Bank to step up its intervention in support of its country’s currency, its stock market and global investors’ confidence, materially contributing to stabilize the turmoil in the markets and initiate a rebound.

With concerns over China fading away thanks to the reinsuring determination shown by the PBOC and the Chinese Government to support markets and their slowing economy no matter the costs involved, investors have switched back to “Risk on Mode”.

This was marked by the return of equity buyers happy to pick up stocks at discounted prices in an attempt to capitalize on the recent correction or to recoup some of the losses incurred in the panic sale that dominated the news over the end of last week and the beginning of this.

The questions now are, what do this week’s price swings mean for the markets? And how should this week’s market rallies be played by those investors who were too cautious or afraid to dive into the market in the midst of a selloff?

When it comes to the first question, the reality is that after months of relatively low volatility over the first half of the year, this summer markets have been dominated by levels of volatility to which investors have grown not to be accustomed to; and for once, Central Banks such as the FED and the ECB will be quite refrained from quickly accommodating markets’ expectations for immediate monetary easing.

This, combined with lower liquidity, typical of the summer holiday season, has contributed to exacerbated larger price swings seen as rather unusual for the current post financial crisis, central banks driven market environment.

Traders and investors would do better to remember that volatility is not necessary your enemy, and if you are able to manage your portfolio, volatility is what allows you to make money.

Sure, volatility did not feel like a friend to the average retail investor that saw the value of his/her investments plunging over the span of a few days, and certainly, investors that were badly burnt by the sudden market correction, will now think twice before jumping back in the ring. However, this week’s equity rally seems to suggest that the investment strategy focused on buy on pull backs and sell into the rally may still prove quite profitable.

In respect to the second question, things may be more complicated, as investors who decided to remain on the side line, missing this week’s rally, might find themselves attempting to re-enter into the market just when the winners of the week prepare to take profits off the table.

And here comes the real question: is the rebound here to stay, or will the markets sell into the rally, ahead of the FED meeting only two weeks away? The view of several analysts surely seems to be: a one day rally is just the market adjusting itself, a two days rally is the market normalizing after a pull back, a three days rally must be real rebound!

So far equities seems to confirm this view, with US stocks posting their best daily rally in over four years on Wednesday, adding other solid gains yesterday and positioning themselves for another strong opening today. Asian markets extended the gains recorded yesterday by closing up this morning, with the Shanghai Index adding 4.82% and the Nikkei 225 advancing 3.03%.

European markets followed the US posting three straight days of gains, although they opened lower this morning suggesting that winning investors are now taking some profit, while assessing what the next move should be.

This article was issued by Paolo Zonno Trader/Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt .The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.