Here’s how to interpret (and tackle) the recent plummeting of the equity markets

6 February 2018
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Equity markets don’t just go up, they can also fall along the way. The recent nosedives in the Stock Markets all over the world were a reminder to many who had forgotten this simple Stock Market rule, after years characterised by the absence of significant corrections and widespread rising underlying trends.

On the other hand, it was expected to happen sooner or later. The signs were certainly there, starting with the evident steep climb in the graphs of US share indexes. Another early warning sign came was the extremely low levels of volatility implicit in the S&P 500 index, the well-known Vix. Too low. Seeing the Vix remain at around 9 for a long time when its historical average sits in the 12-15 range was clearly an anomaly. Now, albeit with a sharp movement, volatility is rising back to its natural levels, with the Stock Markets getting their wind back following a long difficult stretch.

Therefore, there are corrections in the equity markets, and they will always be present. But how long will this phase of significant profit-taking last? It depends on various factors, such as the intensity of the force of the descent and the speed of the return from expansionary monetary policies by Central Banks like the Fed and, looking further ahead, the ECB. It is likely to last a few days, perhaps stretching to a few weeks. Also in this case, it would still certainly remain confined to the “correction” status, not a change of course. At least from what we have seen up to now.

If this scenario is not nullified by new destabilising factors, then the phase of correction in progress may have what it takes to become a purchase opportunity further down the line. Once Wall Street shows signs of settling down, we’ll be able to enter the equity market again. On what securities, by continuing to focus on the Italian Stock Market? One of the burning issues remains that of PIRs (individual savings plans) and therefore, the most interesting Italian small and medium caps. By contrast, as regards big caps, we need to be a bit more selective, by adhering to the principle of rotation towards securities that had previously remained on the margins of the recent upward movement. We’ll certainly need to be selective in relation to Italian banks. The sword of Damocles of share capital increases implemented to cover the excessive exposure to non-performing loans is always hanging over us and will stay there in the long-term but, in any case, any problems will affect the individual bank and will no longer constitute a systemic risk like in the past.

By Massimo Trabattoni, Head of Equities for Italy at Kairos, for AdvisorPrivate’s Italian Times column.