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On pause: the one-way certainty of the market is over … for now

Neil Robson
Neil Robson
Head of Global Equities

The macroeconomic backdrop is changing, or at least uncertain. This could shift the pricing of risk assets, but it won’t change what we do, which is look for stronger competitively advantaged businesses that fit our quality growth philosophy

When we invest money on behalf of our clients, we seek superior businesses with durable competitive advantages and commensurate high returns on capital. The aim is that the compounding nature of these businesses builds wealth over the medium and long term.

But not every market participant shares the same goal. Much of the volume in the market is driven by shorter-term traders, many of whom are exploiting strategies they believe can generate return while diminishing risk. Occasionally these strategies can add significant volatility to returns.

We have just gone through a period where such strategies have been disappointed. The recent spike in volatility in the chart of VIX (the Chicago Board Options Exchange’s CBOE Volatility Index) can be seen as a sign of these strategies being frustrated and closed out on a massive scale (Figure 1).

Figure 1: A spiking VIX
spiking VIX

Source: Bloomberg, as at 16 August 2024

I am far from an expert in such strategies, but a non-exhaustive list would include: trend-following calls to action; risk parity asset allocators; equity baskets; the Yen carry trade (funding in a low-cost currency that was a “one-way” bet lower); and theme ETFs (AI beneficiaries, obesity, Japan value etc). They had all been making money until the market rotation unsettled them and sent them heading for the exit. Japan falling 12% in a day1suggests technical-dominated trading. It reminded me of the 1987 crash (I was very young!). Back then, before the October investors had also made a lot of money. The Federal Reserve had already raised rates three times, the last being a 50bps rise to 7.25% in the September2.But suddenly in mid-October everyone headed for the exit at the same time. The culprit then was portfolio insurance, a strategy that promised equity-like returns with significantly lower downside risks; the trigger was an above-expected trade deficit number; the result was the creation of forced sellers and a market event. The spike in volatility as the S&P fell 23% in a single day was such that initially those owning calls made money on the drop as the spike in volatility overwhelmed the price drop in a Black-Scholes3 valuation world (this may be an urban myth).

Coming back to today, we have just seen a spike in volatility not far short of that seen during the collapse of the financial system during the Global Financial Crisis (GFC) and with the onset of the Covid-19 pandemic. What caused it this time? Apparently, initial jobless claims in the US were a bit higher than expected and suddenly we were heading for recession (subsequent examination of the data showed an increase in the labour force participation rate was to blame).

We live in a capitalist world and as such price is meant to be a signal. So, what has recent price action told us:

  • Economic growth is slowing. The odds of recession have gone up, but are still slim.
  • We are leaving the post-pandemic period of high inflation … at least for now? (Figure 2)
Figure 2: US CPI excluding food and energy
US CPI excluding food and energy

Source: Bloomberg, as at 16 August 2024

Figure 3: Federal Funds Target Rate
Federal Funds Target Rate

Source: Bloomberg, as at 16 August

Bond yields are reflecting all of this, and the cost of capital is falling. Though the steepening of the yield curve suggests we are not set to go back to the low level of bond yields experienced in the post-GFC period.

Perhaps the biggest signal from recent market movements is that the one-way certainty of the market seen in the first half of this year has reached a pause. The macroeconomic backdrop is potentially changing, or is at least uncertain, and this may change the pricing of risk assets.

If economic growth is slowing, recession risks are rising, inflation is falling, and interest rates and the cost of capital are set to decline, surely those companies that can generate revenue and profit growth against that backdrop are more valuable. This leads us back to the secular trends in the market, the wealth creation by companies exposed to the secular trends but with the competitive advantage to exploit them profitably.

In 1987 the stock market crash did not bring a major change in fundamental trends. After a brief period of accommodation by the Federal Reserve interest rates continued to rise, peaking in early 1989 at 9.75% (a different age). Despite this the S&P hit all-time highs in 1989, although the rising cost of capital did manage to puncture the bubble of the time – the Japanese equity market. My memory is not good enough to remember if there was a change in equity market leadership, but I don’t think there was.

What drove the market was the value creation from restructuring western companies exploiting the potential for lower costs from outsourcing and globalisation of the supply chain. This was the era of economic value added (EVA) and Stern Stewart, with their first big implementation being Coca Cola in 19884. It was the dominant trend in both management thinking and the stock market. As a result, the market was led by value stocks for two decades (effectively 1980-2006, with the minor aberration of the tech bubble), as this was where the greatest value creation was occurring at the time.

Today, the average company is decently profitable. There is little to be gained from further globalisation, and there are forces in the world – both political and economic – which suggest the trend may reverse. What is driving wealth creation are those companies that can grow by innovation of new products and new ways of doing things that reduce the cost of doing business; or by companies that can aid the process of decarbonising the world – changing the energy source of the world is a multi-decade task and will generate sales growth and wealth for advantaged companies. We have entered an artificial intelligence (AI) era and while the ultimate winners may be uncertain, there are some things we can say with confidence: an AI era is a cloud computing era, and the cloud is dominated by three companies. Growth looks assured and with that oligopolistic market structure wealth creation also looks certain.

Beyond the secular growth opportunities in the market, our research is focused on near-term earnings resilience and the potential in names which may see an improved outlook as interest rates are cut. In our experience, stronger competitively advantaged businesses in any industry often gain market share at a faster pace during tougher economic periods. Ensuring companies genuinely fit our quality growth philosophy is, as always, critical.

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On pause: the one-way certainty of the market is over … for now

1Bloomberg, as at July 2024
2Bloomberg, as at July 2024
3Investopedia, Option Pricing Theory: Definition, History, Models, and Goals, 29 September 2021
4JSTOR, Economic Value Added (EVA™): An Empirical Examination Of A New Corporate Performance Measure, Vol 9, No3 Fall 1997

Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.
In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.
In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge who meet the regulatory criteria to be classified as a Professional Client or Market Counterparty and no other person should act upon it. This document and its contents and any other information or opinions subsequently supplied or given to you are strictly confidential and for the sole use of those attending the presentation. It may not be reproduced in any form or passed on to any third party without the express written permission of CTIME. By accepting delivery of this presentation, you agree that it is not to be copied or reproduced in whole or in part and that you will not disclose its contents to any other person.
This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients). For marketing purposes.

 

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.
In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act 2001 (Cth) and relies on Class Order 03/1102 in respect of the financial services it provides to wholesale clients in Australia. This document should only be distributed in Australia to “wholesale clients” as defined in Section 761G of the Corporations Act. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.
In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.
In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.
In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.
In the UK: Issued by Threadneedle Asset Management Limited, No. 573204 and/or Columbia Threadneedle Management Limited, No. 517895, both registered in England and Wales and authorised and regulated in the UK by the Financial Conduct Authority.
In the EEA: Issued by Threadneedle Management Luxembourg S.A., registered with the Registre de Commerce et des Sociétés (Luxembourg), No. B 110242 and/or Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.
In the Middle East: This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge who meet the regulatory criteria to be classified as a Professional Client or Market Counterparty and no other person should act upon it. This document and its contents and any other information or opinions subsequently supplied or given to you are strictly confidential and for the sole use of those attending the presentation. It may not be reproduced in any form or passed on to any third party without the express written permission of CTIME. By accepting delivery of this presentation, you agree that it is not to be copied or reproduced in whole or in part and that you will not disclose its contents to any other person.
This document may be made available to you by an affiliated company which is part of the Columbia Threadneedle Investments group of companies: Columbia Threadneedle Management Limited in the UK; Columbia Threadneedle Netherlands B.V., regulated by the Dutch Authority for the Financial Markets (AFM), registered No. 08068841.
Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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