Markets may be waking up to ridiculous taper volatility

MARKETS have been acting very strangely recently – a bit like the British weather – and have proven difficult to call. This was typified by the reaction of US equity markets on Friday to the most significant data release of the month – the non-farm payrolls. New jobs in June exceeded expectations by 30,000. Good news? Initially, yes. Taking the Dow Jones index as an example, after four minutes the bulls were exchanging high fives with a 60 tick (0.4 per cent) profit.

But an hour and a half later, they were calling up their favourite short-term loan provider after the market had come off by more than 200 points (1.3 per cent). This move toed-the-line with regard to the recent trend, where good news has acted to the detriment of the markets, as the money-addicted indices fear losing their monthly $85bn QE remedial injection from Fed chairman Ben Bernanke.

After everything settled down, however, investors finally realised that this situation – where a bad economy is deemed better for equities – is ridiculous. By the close of play, the bulls had re-paid their weekend Wonga loans and were able to go to the pub on Friday after all: they made a 30 point profit (0.2 per cent).

Bernanke has always said that the QE tap was neither on or off, and that a reduction in stimulus would represent a downward slope rather than a cliff edge. Markets need to see the current situation as a trade-off. As the economy improves, which should be good for profits and equities, QE will reduce. It is volatility that made the markets come off as far as they did. Markets hate uncertainty and are trigger-happy – particularly after such a big push to the upside in the first half of the year. This rise in volatility increased the “risk” associated with the investment, and thus the required return, therefore driving down the price. But in the end, a healthy economy – without the need for a first aid kit – is what we want, and what we will end up with.

Back in June, when Bernanke first talked about tapering, there was mass panic and many markets came off. The FTSE, for example, fell 8 per cent from its highs. This always looked like an overreaction to information that was already known, and those that noticed this (including many of our clients) will be pleased. Did they, however, manage to realise that a few words from the Fed chairman would have such a profound effect? Very few did.

The moral of the story is that, if you are invested in equities at the moment, short-term market moves don’t amount to much and are probably wrong. The US economy is now firmly in recovery mode, and if you had been in Dow Jones equities since 1 January, your $100 would now be worth $116, not including dividends. And that ain’t bad for a half year return. The only other place you can get a return like that is from a Greek government bond, but this is not something I would recommend trying at home.

There is no question that economies are generally past their low points. China may not be growing as fast as it was, but it is still managing 7.5 per cent. Bernanke gives his next speech today, and investors will probably interpret his words as if they are straight from the Old Testament.

But if you are trading the move this afternoon, I suspect you are not feeling that confident you are right. It may be more of an emotional rollercoaster than watching Andy Murray serve for the Wimbledon title.

William Nicholls is a dealer at Capital Spreads.

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