Market fragmentation and correction

Market fragmentation and correction

We have been cautious for the last few months about equity valuation risk amist huge complacency and extrapolation. The move towards passive investing has not helped.

The current market malaise/rout is a partly fundamental and a partly technical phenomenon.

The bloody correction has tied in with an unwind of artificially low volatility (violent squeeze) amidst rate normalcy initiatives which materialise in somewhat dislocated bond markets which are pricing in a juiced-up US economy and the inflation effects thereafter amidst a global synchronised pick up. Inflation breakevens will be keenly monitored.

So many chief strategists, politicians, and the Davos set have shown a total ignorance of markets. They are clearly not experts in this field. They blindly assume that growth (and more of it) is good for markets. Where on earth did they get this from? Growth can be good and bad, and comes with  side effects and a risk warning. For example, companies see profitability and efficiency reduced. And that's bad for markets. Inflation and wage growth can hit companies hard. 

Strong growth (or risky overheating) and lower tax are not necessarily welcome at the end of one of the biggest equity bull markets in history and an even bigger and longer bull market in bonds within an environment, until very recently, of artificially low volatility. You can pump things up for just so long. That goes for earnings growth which makes very expensive multiples suddenly look bearable.

Bitcoin seems emblematic.

The overshooting of the VIX and related instruments and the subsequent redemption of CS low vol instruments makes a correction the other way inevitable.