Calm before the storm?

Many traders believe that markets could be ripe for a technical correction

The steady and sustained rise of most regional and global markets this year has generally been a reason for celebration. But for some it is also a growing source of anxiety, especially among long-biased, high-conviction managers concerned as to whether the run of good fortune that they enjoyed in the first half will continue for the rest of the year.

Several have aired concerns in recent newsletters to investors that the extended period of very low volatility in global markets could quickly unravel, warning investors to remain vigilant and not to lower their guard as markets push new highs.

Many traders believe that markets could be ripe for a technical correction given the remarkably robust gains made since the start of the year – and especially in light of the low market volatility. In June, the VIX index, which is a measure of 30-day implied S&P 500 Index option volatility, continued to hover at record lows and investors were happy to continue pumping liquidity into markets, and into passive investment products particularly.

In Asia, the mood started shifting in July with fluctuations becoming more noticeable. India’s Sensex index – which had risen sharply in the first six months – had a wobble in July, peaking on 17 July and giving back some gains the next day in one of its strongest corrections this year, only to advance again a few days later.

Japan’s Nikkei and Topix indices also see-sawed this month and the big question hanging over the market was whether those were simply technical corrections or whether valuations have really gone too far.

One key market to watch closely is China, given how fluctuations in its market now reverberate powerfully across global markets. The consensus among market watchers seems to be the Chinese government will employ all means to stabilise the market in the coming months before the huge plenum of Chinese leaders in October – to ensure that short-sellers are not able to take advantage of any weakening sentiment as they have done in previous years.

The Chinese regulator is well armed with all the necessary means to stall another major market correction. But PIMCO’s emerging market analysts have warned that China could inject a new wave of uncertainty and risk into global markets if national leaders fail to address structural reforms in a meaningful manner.

Sentiment for Chinese shares, however, looks to be well-supported this time given their upcoming inclusion to the family of MSCI’s emerging market indices that will make them essential for inclusion in global portfolios.

Global investors remain heavily underweight on China, and have been avoiding it for fear that the high leverage in its corporate sector could trigger another stockmarket crash.

But consulting firm Willis Towers Watson, in a report released this month, said that while that was certainly a reason for concern, Chinese policymakers seem fully alert to the problem and capable of dealing with potentially adverse developments.

Another well-known consulting firm, the Boston Consulting Group, in a report also released this month highlighted China’s rapidly evolving sophistication and its pivotal role in the future growth of the global asset management industry.

It noted that China posted the only growth in terms of assets among the major geographies last year – describing it as exceptional – although the report also noted that many asset managers have yet to see much of a return.

However, the firm believes that prospects are improving – with the Chinese market and its investors becoming more sophisticated. “An ageing population and the growth of wealth has expanded demand for dedicated products, including target-dated funds and ETFs, while foreign players are now able to get onshore licenses, and new regulations allow insurers and pension funds to get into the market. Foreign players that also want to participate directly in the market have a growing number of potential entry paths,” the firm said.

This month China opened BondConnect, allowing more foreign money into its onshore bond market, and also awarded UBS Asset Management the second WFOE licence to be granted by the Asset Management Association of China (AMAC). The first licence was granted to Fidelity earlier this year.

The WFOE licence allows UBS to sell hedge funds and other investment products onshore without having to work with Chinese partners or obtain quotas from existing programs such as the QDLP.

China has seen an upsurge in the number of applications by foreign-owned institutions for registration as private securities investment fund managers since January, when AMAC for the first time approved their registration.

The entry of UBS into China should be a significant boost to China’s growing alternatives industry, giving private and institutional investors in the country more access to sophisticated products.

 Global investors remain heavily underweight on China, and have been avoiding it for fear that the high leverage in its corporate sector could trigger another stockmarket crash