These 2 key triggers could bring the next round of market turbulence

Equity index valuations are at elevated levels, potential credit downgrades are looming, and there is the possibility of inflation surprises this year, Citi said, underpinning strategists’ projections.

Financial valuations aren’t consistent with real-side measures like gross domestic product “by virtually all metrics,” according to the bank. This loads the gun for a turbulence trigger.

It could be inflation. The COVID-19 pandemic has laid the groundwork for inflation rates to be volatile in 2021. While Citi said there is “little underlying support” for sustained inflation, missing prices due to the effect of lockdowns and corresponding year-over-year base effects could scare markets.

A wave of turbulence could also be set off by slowing central bank purchases. Projections suggest that both the pace of purchases and net asset purchases will slow this year. Given the fact that net asset purchases are the main road between monetary policy and the real economy, Citi said that a modification to these patterns could surprise markets “no matter how hard central banks try to communicate in advance.”

Any turbulence is likely to hit equity and credit markets, according to the investment bank, because these asset classes are currently displaying volatility higher than recent norms.

So what should investors do? Citi recommends buying the next dip. 

The investment bank’s Global Bear Market Checklist is registering 8/18 red flags following the latest rally, which is the most markers since 2009. The U.S. market has 9.5 red flags while it is lower in Europe, with 5. 

That indicates a fair amount of “froth” in markets—the more frothy, the less inclined Citi’s model is to buy the dip. But it is still enough.

The buzz

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Attention now turns to ushering a $1.9 trillion plan through Congress to aid the pandemic-ravaged economy, including sending $1,400 stimulus checks to Americans.

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