The markets saw heightening volatility this week. The stress was very visible in financials, small caps, and midcaps. The sharp cut in valuations of companies in this place has come as a nasty surprise. What went wrong?
Firstly, investors assumed that growth would last for a long time. Secondly, they believed profitability would hold steady. Third, the assumption was that valuations would remain stable. All three assumptions went into a tailspin when oil, the dollar, and liquidity went out of control.
While all three variables will stabilize over time, market confidence in financials and small caps will not return anytime soon.
This is going to be a big worry for markets in 2019. Indices need new drivers that can replace financials. Investors can’t exit small caps and midcaps. Mutual funds will struggle to hold onto assets when faced with aggressive redemption pressures. This will compound valuation concerns in this space.
Overall, markets need to walk out of their excesses of 2018 with as little damage as possible. This is not going to be easy.