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Summing Up Our Fears 

Krisina Hooper 

The Upshot 


On the heels of a difficult week for US stocks, investors have a long list of reasons to worry. But what’s more likely: all these fears coming true at once—or just more volatility, asks Kristina Hooper?

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Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

Stocks dropped drastically last week as investors sold off risk assets. In fact, the two-day loss for the Dow Jones Industrial Average on Thursday and Friday was the biggest we’ve seen since last summer. The yield on the 10-year Treasury also moved lower as investors went “risk-off,” embracing areas of the market they view as safe.

Last week’s rout seemed to be what the market has been fearing since its big run-up in 2013—a traditional “flight to quality” trade that was repeated in Europe, where peripheral European bond spreads widened as investors dumped those bonds for German bunds.

The catalyst for the sudden loss of confidence seems to have been a weak PMI number coming out of China. The Markit/HSBC Purchasing Managers' Index, also called the flash PMI, clocked in at 49.6 in January, below the key 50 level that marks the line between contracting and expanding manufacturing activity.

This one data point struck fear in the hearts of investors and renewed worries about the future growth of China’s economy. Of course, given China’s lack of transparency and its dramatic growth in credit over the past few years, this apprehension isn’t unfounded. Topping it off, the markets witnessed growing unease over Argentina’s and Turkey’s respective currencies last week, leading to broader concerns about emerging markets.

Adding to the drastic reaction to China’s PMI number were ongoing fears about Fed policy, as markets eagerly await the next round of tapering.”

Jitters Over More Fed Tapering

Still, as we know, one data point does not a trend make. Adding to the drastic reaction to China’s PMI number were ongoing fears about US Federal Reserve policy, as markets eagerly await the next round of tapering. The wind-down of the Fed’s bond-buying program is likely to result in capital outflows from emerging-market countries, as we saw all too vividly when last year’s taper talk turned to taper tantrums.

In fact, the International Monetary Fund has been expressing its own concerns about how US tapering will affect emerging markets. In her address at last week’s World Economic Forum at Davos, IMF leader Christine Lagarde spelled out her misgivings: "This is clearly a new risk on the horizon and it needs to be closely watched… how tapering takes place, at what speed, how it is communicated and what spillover effects it has, particularly in emerging markets."

US Debt-Ceiling Deadline Around the Corner

At the same time, US investors seem to be so focused on China and the larger emerging-market situation that they are ignoring what is perhaps a more significant risk closer to home.

Last week, the US Secretary of the Treasury sent a letter to Congress informing them that the US will reach its debt limit in late February. This is an extremely significant issue, particularly since—given all the expenditures typical at this time of year—the government has far less flexibility with its budget now than it did last fall. While the mood in Washington is far more conciliatory than it was during the last go-round, February is just around the corner, and we would not be surprised to see renewed chest-thumping and down-to-the-wire negotiations.

Even though another debt-ceiling debate should have no long-term impact on stocks, it could result in heightened volatility and diminished consumer confidence in the shorter term, just as we saw last fall. In fact, investor fears never fully abated given that the key debt-ceiling and government-funding issues weren’t permanently resolved—and indeed, now that we are closer to the February debt-limit date, short-term T-bills have been selling off.

Political Turmoil

But that’s not all. A range of outlier risks are growing around the world, with the potential to shake the confidence of already-nervous investors: the possibility of a terrorist attack at the Olympics in Sochi; an escalation in tension between China and Japan; growing unease in the Middle East, especially in Egypt and Syria; and violent political protests in Ukraine and Thailand, to name a few.


Fear or Fundamentals?

But the reality is that there are fears, and then there are Fears. Investors should know the difference. In assessing risk, investors need to assign a probability to that risk coming true as well as the potential impact it can have on investments—especially beyond just short-term volatility.

In this case, while all these fears we’ve elucidated are real, they’re not necessarily going to impact investment fundamentals—and that could help investors keep them in perspective.

For our part, we won’t be surprised to see more volatility; in fact, we always believed it would return once Fed tapering began and the stock market became increasingly supported by fundamentals rather than quantitative easing. But volatility itself shouldn’t be a deterrent to investing—and it could even offer up valuable entry-point opportunities.

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The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue-chip stocks, primarily industrials, but including financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks.

Purchasing Managers’ Indexes (PMI) are economic indicators derived from monthly surveys of private-sector companies.

The CBOE Volatility Index® (VIX®) is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices. Since its introduction in 1993, VIX has been considered by many to be the world's premier barometer of investor sentiment and market volatility. The Standard & Poor’s 500 Composite Index (S&P 500) is an unmanaged index that is generally representative of the US stock market.

Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.

A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.



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