Every year, for the Chinese New Year, Chinese families clean their houses and decorate windows and doors with red paper stripes and couplets with signs for good fortune.
This tradition comes from the legend of the Nian (年獸), a mythical beast who would go to the village on New Years’ eve, eat the crops and sometimes the children. One year, all villagers decided to lit up firecrackers, hung up red lanterns, and wear red robes to fright the Nian. It turned out the monster did not like the color red and was afraid of loud noises. The famous Chinese lion dance (舞龍舞獅) was born and the Nian never returned to the village.
As we get ready to celebrate the transition from the Fire Rooster to the Earth Dog year, it looks like the Nian came back to the financial markets quite flamboyantly. He reminds us that the end of an expansionary economic cycle often coincides with the beginning of a new era of volatility. This time the Nian was not scared of equity markets in deep red, and noises of despair on trading floors as markets were thrown into a tailspin when rising bond yields triggered a sell-off in stocks.
It all started well. 2017 turned out to be a year of awakening in monetary and fiscal policy, politics, and markets. The crowing of roosters is often a natural wake-up call. Throughout the year, the footprints of the Fire Rooster were visible everywhere: They helped Emmanuel Macron take France (the gallinaceous’ home country) and Europe back to center stage; they gave President Trump an extra boost to his comb and his America First economic policies; and they provided President Xi with the right amount of grit – roosters’ main quality according to Chinese astrology – to build a global China one step at a time.
The good news is that the Nian could be less cruel than in previous times. No need to eat all the profits and dividends. The ongoing market correction does not reflect a worsening of economic and corporate fundamentals. It is mainly driven by technical factors, including the unwinding of short-volatility trades, already stretched valuations and jittery investors used to complacency.
Central Bankers had been quite clear about their intentions all along. Growth, inflation and debt have increased, and they are getting ready to start draining the global economy of some of the trillions of dollars they have pumped into the financial system in recent years. Financial markets will automatically feel less numb, and though investors will eventually refocus on the healthy economic backdrop, volatility will remain elevated.
The end of cycle, just like the end of a Chinese year means markets are acutely sensitive to shifts in expectations – for interest rate increases and the Nian. 2018 is a pivot year in many ways: For the US where pro-cyclical policies take the economy into unchartered debt territory; for Europe where the very vulnerable political landscape contrasts with the economic momentum; for China, where atypical policy-making continues to awe international observers. In an environment of widespread beggar-thy-neighbor policies, the importance of dialogue and solidarity, frugality and creativity – all promised by Chinese astrologists for the year of the Earth Dog –, will be very much needed. Failing to do so could end up in unnecessary barking on markets, political stages and in the real economy.
The VIX index - a gauge of volatility - surged in 2018 (compared to 2017 average)