Volatility traded sharply upwards in the following days and two inverse volatility Exchange Traded Products ended up being liquidated. The S&P500 fell over 10% over the course of the next few days and subsequent US Core CPI data served to confirm the reality of higher prices. The well above expectations number for CPI was negative for bonds, as expected, but equities rallied hard after an initial short sell off. The price action perhaps tells us that the normalisation from the volatility shock is more dominant for markets for now than the data. In our view, the February sell-off was a systematic one rather than a correction prompted by a deterioration in economic fundamentals. In that respect, it was akin to the flash crashes experienced in August 2015 and January 2016.
We think it is too early to call an end to the equity bull market. Despite the rising inflation risk to asset prices, strong underlying growth should underpin earnings. We remain relatively positive on the prospects for equity markets and geographically we continue to like the emerging markets. Valuations look reasonable relative to both history and their more developed counterparts. We are also positive on Europe where we expect growth to better expectations with domestic demand increasing and the region (especially Germany) geared into emerging market strength through its exporters. Prospects for the UK look more subdued however – a function of Brexit associated uncertainty and sterling appearing vulnerable. The likelihood of higher inflation means we have become more cautious on US Treasuries and investment grade credit.