Don't stress! The stock market is 'a long way from a crisis'

After a bright start to 2023, shares have sunk again after multiple bank failures. What's doing?

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Investors could be forgiven for thinking the rally in the S&P/ASX 200 Index (ASX: XJO) to start the year was yet another false dawn.

The market has dropped almost 6% since the February peak, to deliver a brutal reality check to stock portfolios.

Of course, a lot of the stress this month relates to US and Swiss bank failures. It seems after steep interest rates rises over the past year, parts of the system are buckling under pressure.

It's all enough to make your hair turn grey.

"The press is filled with stories of banking failures and global financial crisis (GFC) analogies," Wilsons head of investment strategy David Cassidy said in a memo to clients.

"Equity markets have fallen ~3% this month, and demand for safe haven assets has risen."

So are we on the brink of another crisis?

Volatility spike vs financial crisis

Fortunately for investors, Cassidy reckons what we're experiencing now is merely a "volatility spike", rather than a full-blown disaster.

"Our analysis suggests that in comparison to genuine 'crisis' periods such as the COVID dislocation of 2020 and the GFC of 2008, most market stress indicators are still a long way from 'extreme' levels," he said.

"Key indicators of economic activity suggest conditions remain relatively solid, although a growth slowdown is widely expected (and we agree)."

Out of all the measures that Wilsons analysts use to measure market stress, the Merrill Lynch Option Volatility Estimate (NYSEGIS: MOVE) is the one that's most outside of normal levels.

This index represents interest rate volatility.

"This is arguably not so much an indicator of severe current market stress but an expression of a heightened fear that the Fed could overtighten, causing a recession, a genuine banking crisis, or both," said Cassidy.

"Importantly, we do not see a credit dimension to current banking strains, so the Fed still has some wiggle room."

Cassidy fully admits that share markets are "jittery". 

"But the real economy continues to look robust."

What will happen from here?

Cassidy forecasts that stock markets will soon "settle down" and refocus on growth and inflation fundamentals.

"While there are still risks in this fundamental backdrop, we do see prospects as looking encouraging for a relatively orderly slowdown in both growth and inflation," he said.

"This should see equity markets lift again in response."

But the Wilsons team will be vigilant on all the metrics, as the situation can change quickly.

"We will continue to watch our stress indicators closely for warning signs of more severe strains."

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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