Add me to those who, once again, were impressed by the resilience that financial markets demonstrated to unanticipated news last week. Remember the May 2013 "Taper Tantrum"? It used to take weeks for markets to digest unexpected events and bounce back. Now, reflecting in large part a deeply engrained "buy-on-dips" mentality, it takes just a few hours, if that.
The initial market reaction to the news of a U.S. strike on Syria last week had all the elements of a "risk-off" move: a selloff in stock futures, lower yields on U.S. Treasury bonds, and higher gold prices. A few hours later, however, markets were well on their way to rebounding -- only to be hit by a headline job creation number of just 98,000 for March, or almost half the consensus estimate of 180,000.
Once again, the initial risk-off reaction wore off quickly, even after Russia's angry reaction to the Syria attacks and the news of a terrorist attack in Sweden. Indeed, the major U.S. stock indices ended Friday's trading session essentially unchanged from where they were before this sequence of events. Meanwhile, bond yields closed higher (rather than lower) on the day, and gold prices pared their gains to just 0.2 percent.
Admittedly, the negative impact on risk assets of all four news items was offset by individual considerations. Specifically,
The U.S. strike on Syria was narrowly targeted, tactical, and deemed appropriate by the vast majority of the international community. As such, markets did not consider it a prelude to new conflicts involving the U.S. The disappointing headline jobs number was offset by better internals, together with solid wage growth. It was not seen as an indicator of a fundamental weakening of the labor market. The Russian reaction was seen as political theater for domestic consumption, rather than as a signal of significant tensions in the country's relations with the U.S. The tragic attack in Stockholm was viewed as the sick act of a lone wolf rather than indicative of a broader terrorist threat.
Nonetheless, the price action also serves as yet another illustration of one of the markets' distinguishing features in the recent past: resilience. And it is the result of behavior that, at least so far, has served traders and investors well when it comes to making money -- that of buying on dips.
This investor reaction is underpinned by strongly held beliefs in the marketplace regarding the underlying stability of global growth dynamics, the continued backing of central banks, the likelihood of large inflows of corporate cash, and the containment of adverse political spillovers.
Yet recent data also points to some potential cashflow strains, including the largest weekly outflow of retail investor funds from U.S. stocks for more than 18 months. Moreover, the original August deadline set by Treasury Secretary Steven Mnuchin for tax reform looks less certain, raising questions about the timetable for the repatriation of corporate cash held abroad. Meanwhile, the low growth equilibrium risks are becoming less stable and central banks are less able and less willing to continuously repress financial volatility.
For all these reasons, growing exposure to market risk is gradually being borne by a slowly shrinking base of investors. This is not much of a concern as long as unanticipated shocks remain relatively infrequent and containable. Indeed, the minority of investors who have reduced their portfolio exposures could even be attracted back in.
The picture changes significantly, however, if negative shocks become more frequent and more generalized. As such, market participants would be well advised not to lose sight of the uncertain political outlook in Europe, the potential quick sand in the crisis-ridden countries of the Middle East, rising tensions over North Korea, and the economic policy pivots that Europe and the U.S. need to make to place their economies on firmer footing and validate high asset prices.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco.