The `Goldilocks Market' Is Over: Lessons From the Stock Sell-Off

(Bloomberg) -- Calm pervaded equity markets Tuesday, with indexes in Asia following U.S. gauges higher and a measure of Japanese stock volatility plunging as much as 36 percent.

The respite gave investors and analysts a chance to reflect on the recent selloff, which sent benchmark measures including the S&P 500 Index and the Nikkei 225 Stock Average down 10 percent from highs, meeting the accepted definition of a correction.

While veteran investor Hugh Young of Standard Life Aberdeen Plc dismissed the downturn as nothing new -- and certainly no comparison to Black Monday of 1987 -- others saw it as a turning point when markets returned to reality.

“The Goldilocks market is completely over,” said Norihiro Fujito, a senior strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo, referring to the sweet spot seen in 2017 of strong economic growth, good corporate earnings and low interest rates. “There’s a high possibility U.S. Treasury yields will rise further. You shouldn’t cherish your good memories of last year.” Japan’s Topix index slipped 0.9 percent Tuesday.

Here are some more takeaways:

Investors Were Complacent

“People didn’t take the U.S. stocks decline seriously in the beginning,” said Ronald Wan, chief executive at Partners Capital in Hong Kong. “Global equities were at their peaks and people also ignored whether the elevated level” was supported enough by the economy. “The peak of this bull market” is behind us, he said.

“The biggest risk doesn’t come from fundamental elements: it comes from within -- complacency and overlooked volatility,” said Margaret Yang, a strategist at CMC Markets Singapore Pte. “When the market is full of complacency, investors should be more vigilant and probably take some hedging measures,” she said. Still, “I remain cautious positive on the stock market in 2018.”

"Investors had become complacent,” said David Grayson, co-founder and chief executive officer of Auerbach Grayson & Co. in New York. “The world forgot the market does go up but it does go down too. Never lose sight of that and be prepared with a wishlist of opportunities you would like to buy but may have been too expensive until a correction."

This Time Is Never Different

“It has been a reminder that ‘This time is never different’,” said Frank Benzimra, head of Asia equity strategy at Societe Generale SA in Hong Kong. “We have a return to normalcy, that is, equity is a volatile asset class.”

“The SG Asia equity outlook included three investment themes: the need to protect against a S&P 500 correction, the Asia consumer, and style rotation going into the new year,” Benzimra said. “The correction in Asia equities suggests I could have highlighted more the first point.”

It’s Not a Rout, 1987 Was a Rout

I’ve learned “no lessons in particular” from the selloff, said Young, head of Asia at Standard Life Aberdeen. “This is not carnage -- at least not yet. Pullbacks and corrections are bound to occur after such strong rises and are a healthy reminder of the inherent risks of investing. It’s not a one-way street.”

“It’s not a rout, 1987 was a rout,” Young said. The S&P 500 Index fell more than 30 percent that year.

Factor in Leverage

“Panic breeds panic, but one of the critical factors that I have started to factor into my risk equation is the unbridled use of leverage that tends to exaggerate short-term moves,” said Stephen Innes, head of Asia Pacific trading at Oanda Corp. in Singapore.

“We’ve seen this for years in China where highly leveraged crowded positions topple like a house of cards when risk aversion rears its ugly head,” Innes said. “So while it’s impossible to absolutely quantify the amount of market froth based on leverage positions, we will factor in an X percentage into our worst-case scenario exit strategies. My quants are busy crunching numbers trying to come up with a percentage.”

To contact the reporters on this story: Abhishek Vishnoi in Singapore at avishnoi4@bloomberg.net, Keiko Ujikane in Tokyo at kujikane@bloomberg.net, Moxy Ying in Hong Kong at yying13@bloomberg.net.

To contact the editors responsible for this story: Divya Balji at dbalji1@bloomberg.net, Tom Redmond

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