Expert Opinion: Why has financial market volatility picked up?

As financial market volatility has risen in recent months, most recently with the Russian invasion of Ukraine, asset managers from Handelsbanken discuss the factors at play in their latest Investment Insight.

Setting the scene for a perfect storm of volatility

The COVID-19 crisis appeared to come out of nowhere, and was essentially treated like a natural disaster by both financial markets and policymakers around the world. Riskier asset types like shares swiftly accounted (in their prices) for the sudden stop in economic activity, but then swiftly bounced back. For most of the period since, we’ve observed the global economy moving from the ‘early-cycle’ phase of its perpetual cycle (a time when policymakers intervene to set the scene for economic recovery), to the ‘mid-cycle’ phase (an expansionary period, when new growth can be harnessed).

In the latter part of 2021, the prospect of economic re-opening, supply chain disruptions and ultra-supportive central banks manifested in a sharp rotation in investor preferences for styles and sectors within the stock market. Nothing fundamental had changed for many of the stock market’s prior winners, but investors started to place a lower relative value on these assets. This relative ‘de-rating’ essentially characterised the first phase of the recent volatility markets (November and December).

The second phase was related to a shift in central bank rhetoric, with markets surprised by how quickly policymakers planned to unwind the emergency support measures previously put in place (ultimately a healthy sign recognising economic recovery). This exacerbated the aforementioned rotation in investor preferences, but also meant that portfolios with a significant allocation to government bonds struggled
with falling bond prices and rising bond yields. Moreover, it caused indigestion for shares of all kinds, hence most market indices experienced declines.

Meanwhile, the stage was being set for a third phase of market volatility. Russia was openly misleading the world whilst preparing for an unprovoked invasion of the Ukraine. Whether to gain control of natural resources or to just threaten the European bloc, the move is designed to finish what it started in 2014 with the annexation of the Crimean peninsula. Energy and soft commodities (like agricultural products) have seen sharp price rises, which will have ripple effects around the world. It may also be a long drawn out conflict, but the media often has a short attention span, and the conflict is unlikely to remain front page news forever if so.

All three phases of market volatility have caused disruption to all kinds of investors.

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