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Gung-ho over surging stocks? Brace for wild swings in the year ahead

By Abheek Barua

The wild gyrations in the stock market on D..

By Abheek Barua

The wild gyrations in the stock market on December 18 as the election results for Gujarat came in reminded us that volatility — the two-way movement in asset prices — is not dead. It just took a rather long vacation. Its return this time was in a bit of a cameo role. The volatility lasted for a day, and then the stock market began rising again. However, it may feature more prominently on the playbill in 2018.

A few things need to be kept in mind when trying to understand volatility. One, the Indian financial markets are not influenced by domestic news and events alone. Reportage and analysis of our market still suffer from a 'home country bias', a rather misguided search for factors within domestic economic policy or politics to explain market movements.

Look West
As links to the global financial markets have intensified, we increasingly tend to catch a cold when others sneeze. So, it is important to keep a close watch on developments elsewhere, particularly in China, Europe and the US.

Second, markets turn frisky largely on the back of political events and the occasional natural disaster. For 'economic' events to really shake the markets, they have to carry enough heft. Thus, markets could panic if there is a sudden bankruptcy of a large European bank, or exultation if a key US legislation sees the light of day. However, routine economic policy is often anticipated and policymakers take care to prep the markets before the announcement to prevent shocks.

Take monetary policy. There is copious discussion in the financial press and in investment bank research reports on the US central bank's plan to shrink its balance sheet (squeeze the dollar liquidity that's sloshing around) and keep hiking its 'policy' interest rates in 2018.

The prospect of the European Central Bank slowly turning off the spigot of cash that it was flooding the markets with has also been parsed down to the last detail. However, these 'expectations' are already baked into asset prices and unless one of these central banks produces a nasty surprise, the policy announcements when they do happen could leave the markets cold.

Why, then, should we fear a more sustained return of volatility in 2018? For one thing, there is the business of history and its annoying habit of repeating itself. A study by US fund house Blackrock looks at data on US market volatility from the 1950s and finds that the stock market is all about long stretches of calm followed by sharp rises in market gyrations. Some of the indicators that presage a rise in market turbulence seem well in place.

For instance, the popular Chicago Board Options Exchange (CBOE) VIX (volatility index) for US stock markets has been stuck at the bottom of its long-term range over the last couple of years. This could be the proverbial calm before a storm, both for the US and our local markets.

What could flip the switch to take the markets from a regime of untrammelled rise to a period of frenzied movement in 2018? If political uncertainty is indeed a driver, there's a long list of major political events due.

Volatility Ahead
In India, there are eight state elections of which four — Karnataka, Madhya Pradesh, Rajasthan and arguably Chattisgarh — are likely to have national ramifications. The results and the phases of anxiety that precede the actual results (particularly since these would be a bellwether for the 2019 general elections) could mean both large-scale buying and selling in the markets and drive swings in prices.

Besides, the likely announcement of 'vote-catcher' policies (a large hike in minimum support prices (MSPs) for farm produce, for instance) in the run-up to the 2019 elections will keep raising the bogey of the fiscal recklessness. While this could dampen the spirits of the market, the predictable repartee from GoI pledging a commitment to fiscal discipline could release an offsetting flood of endorphins. The net result could be periods of weakness in the markets followed by a surge.

International politics might not provide much succour. The US is scheduled for mid-term elections to its two houses of Congress possibly in November. These mid-term elections are generally regarded as a referendum on the sitting president. Going by history, the incumbent party tends to lose ground in such elections.

If the polls hobble Donald Trump's ability to overhaul laws, he may make an effort to govern through executive order. This could mean that the already fractious US political environment could turn worse.

Meanwhile, the rise of the Eurosceptic, anti-immigrant Right continues. A fractured election mandate last October means that German chancellor Angela Merkel is in no position to read the riot act. Italy is likely to have elections in spring. Markets will try and guess if the mandate could mean yet another referendum on the common market staying intact.

Finally, there is the matter of oil prices. Oil price movements are largely a play both on West Asian politics and Russian President Vladimir Putin's predilections. While the market consensus is that it will settle at around $65 to the barrel, the divergence in forecasts between different forecasts (Opec and the International Economic Agency) is cause for concern.

This is not a 'view' on the direction of Indian markets. They could, if the stars so align, gain further over 2018. But there is enough reason to believe that it might be a steady uphill climb. Investors need to watch for cracks and crevasses.

The writer is chief economist, HDFC

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The post Gung-ho over surging stocks? Brace for wild swings in the year ahead appeared first on News Wire Now.

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