The market's sharp fluctuations have also released positive signals: returning to normal

According to the Wise Finance APP, the recent volatile market has made investors uneasy. Columnist Mike Dolan from Reuters wrote that the seemingly chaotic financial market may just be a normalization process, ultimately helping to isolate investment portfolios rather than causing them to fall into distress.

Dolan pointed out that in the past week's intense fluctuations, a bubble has burst. However, this bubble mainly appeared in high octane value trades, which not only relied on low market volatility but also helped maintain volatility at low levels, at least for a period of time. Therefore, what we may be seeing now is that despite some noise, volatility is quickly returning to historically familiar levels.

Dolan believes that for the performance of most traditional mixed asset investment portfolios in turmoil, ordinary investors should feel somewhat reassured. Over the past year, stock and bond prices have basically moved in sync. For many investors, this positive correlation has long been a major concern as it reduces the benefits of holding two types of assets. But what we are seeing recently is a reversal, with bonds and stocks once again becoming natural hedging tools for each other.

When the S&P 500 index fell from earlier this month to Monday's low point, the U.S. Treasury price index rose by about 4%. For traditional 60/40 investors, this is still an overall blow, but much smaller than the potential damage caused by extreme stock market volatility. This is crucial for avoiding the frightening "de-risking" of investment portfolios.

In other words, the trading bias of "good news is bad news" has once again reversed. In the past two years of high inflation and rising interest rates, factors that exacerbate this situation often simultaneously impact borrowing costs, bond prices, and stock prices.

But now the situation seems to have changed, with inflation almost back to the Fed's target range, and Fed Chairman Powell seemingly powerless. Concerns about the cyclical nature of economic growth, such as last week's unexpectedly sharp rise in the unemployment rate, may weigh on the high-flying stock market but also boost bond prices as it increases the possibility of the Fed easing monetary policy.

Most importantly, we now seem to be witnessing the normalization of the key "fear index," namely the Wall Street VIX index. After persistently remaining far below normal levels for nearly 18 months, the index experienced explosive changes on Monday and then seemed to be returning to historically normal levels At the end of this year, the volatility index futures, which hit a record single-day increase in the index itself, have since calmed down and returned to a level almost identical to the 30-year average.

As GAM Investments strategist Julian Howard commented on Thursday, "Market volatility is in line with the region, not a reason for widespread hysteria."

Historic or Hysterical?

This rapid reset has provided little clues as to the possibility of future economic recession or whether the high valuations of large tech stocks and their new artificial intelligence toys can be sustained.

However, it helps to realign the market away from extreme positions that are more likely to cause shocks when consensus thinking is challenged. Of course, the latest assumption is that we will see a sustained economic expansion, allowing low volatility trading to continue to thrive.

Regarding economic recession, the latest forecast from Morgan Stanley is that there is about a one-third chance of the U.S. economy entering a recession in the next year. This somewhat pessimistic view still assumes that the most likely outcome is a "soft landing," where inflation is controlled without triggering a painful recession or a sharp rise in unemployment. The probability of an economic recession in any given year is typically 20%.

As the Atlanta Fed's real-time "GDPNow" model still shows a high economic growth rate of 2.9% for the current quarter in the U.S., there are bold predictions from outside that the economy will enter a recession next year.

It seems more certain that the Federal Reserve will start cutting interest rates next month regardless, mainly because the Fed believes that the current "real" policy rate is too tight for a weak job market, even with inflation under control.

The extent of this easing cycle may be less than what the linear decline in U.S. Treasury yields and money market bets this week imply. However, the Fed's ability to prevent an economic downturn through rate cuts will impact the stock market in any case.

Stephen Dover of Franklin Templeton Institute pointed out that after the first rate cut by the Fed, even in the event of an economic recession, the average one-year return rate for the stock market is close to 5%. Without an economic recession, this ratio is 16.6% On the other hand, in an environment where volatility is more normal and concerns about a recession intensify, high stock valuations and doubts about artificial intelligence may prompt investors holding mixed asset funds to rebalance away from stocks. If this shift occurs, it could bring significant adverse factors to the stock market.

Analysts at Morgan Stanley pointed out that despite the sharp drop in stock prices last week, global stock allocations are still well above average. If valuations only revert to the average level of the past decade, stock prices could further decline by 8%.

Moreover, the outbreak of violent fluctuations always carries the risk of triggering chain reactions, especially because nervous investors may start asking a fundamental question: "What if this situation happens again?"

Jitesh Kumar and Vincent Cassot of Societe Generale pointed out: "The biggest conclusion drawn from this week's price action is that all risk managers must now simulate a 50-point increase in the volatility index within two working days, forcing every prudent investor to deleverage." Alternatively, perhaps risk managers should always imply that such extreme situations could occur.

Therefore, despite the recent days of various tumult and anger, the return of a more "normal" market buzz is likely to provide investors with a safer and more sustainable environment.