Markets

Rise of passive investment could see stock markets tumble even further

Stock markets turned red again on Monday, as last week's sell-off maintained its grip on trading floors throughout the world.

There are many rational reasons why specific equities, or the market more broadly, may have taken a knock.

Signs of core inflationary pressures across the pond arguably triggered last Friday's bearish turn, with strong growth signals in Europe also suggesting that 2018 may finally be the year that central bankers are forced to substantially tighten their grip on the economy.

Read more: Wall Street follows FTSE 100 in steep fall as global sell-off continues

More specifically, pressure on oil and other commodities weighed on stocks in the US on Monday, especially those of big energy companies, while new financial regulations dragged down Wall Street's banking giants. On this side of the Atlantic, Brexit wobbles continue to haunt investors.

Some analysts, therefore, view the last couple of trading days as a likely blip.

"This sell-off doesn’t change the fundamentals," Charles Stanley's investment chief said.

"The prospect for equity markets in 2018 still looks bright."

The bears, however, are sharpening their claws. Claims that the current longstanding bull run is based on a "melt-up" have grown louder. Even outgoing Federal Reserve chair Janet Yellen used the dreaded B-word when quizzed about asset prices.

"Well, I don't want to say [market valuations are] too high. But I do want to say [they're] high," Yellen said on Monday. "Price/earnings ratios are near the high end of their historical ranges."

With regards to other asset prices, such as real estate, she added: "Is that a bubble or is it too high? It's very hard to tell. But it is a source of some concern that asset valuations are so high."

Those who believe markets have become dangerously frothy may have noticed a stark warning from JP Morgan analyst Nikolaos Panigirtzoglou.

Panigirtzoglou argues that stock markets face a "major risk" from retail investors panicking and pulling out of equity-exposed exchange traded funds (commonly known as ETFs). As they withdraw, they will "magnify" any significant sell-off.

Whether that sell-off is happening now, or happens at some other point in the future, the rise and rise of passive investment, through products such as ETFs, undoubtedly risks exacerbating the next major market downturn.

Read more: Carillion's crash shows the value of studying the firms in which we invest

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