The recent sharp pullback and volatility in global equity markets is not yet over, according to the chief executive of financial advisory firm Longview Economics, who said that market models show a "third wave" of the market correction is coming.
"The idea that it's all done in one sell-off is, I think, probably a triumph of hope over reality," Chris Watling told CNBC Wednesday.
Instead, Watling said that market analysis and history showed that sell-offs "tend to happen in three waves," explaining the typical pattern of these:
"You get your vicious first wave sell-off that we had with the high on January 26 in the U.S., then you get your typical wave two relief rally which we had last week when the S&P was up 6 percent, the best weekly performance since 2011, then you tend to get a third wave to either new lows or testing the lows from the first wave of the sell-off."
Watling's comments come as investors still appear cautious after the recent sell-off, that saw indexes around the world plummet amid fears of rising interest rates and higher inflation, which traditionally make equities less attractive. Markets will be keeping a watchful eye on the latest minutes from the U.S. Federal Reserve, due Wednesday, for insight into the bank's outlook on those metrics.
Watling noted that building up to the first sell-off in late January, the market had seen "two years when the market pretty much went up in a straight line and the complacency was huge." He said this was evident in phrases like "melt-up" being commonplace and investor grandees like Ray Dalio, the founder of Bridgewater Associates, forecasting a market surge.
"There's huge complacency … Everyone's talking about a 'healthy market correction' but generally when you have proper pullbacks people are slightly fearful of the bottom — they're not regarding it as wonderful. So, typically, that 'third wave' is key and I think there's probably some more downside risk over the next few weeks."
Watling is not the only strategist to be warning of more volatility to come. Andrew Sheets, chief cross-asset strategist at Morgan Stanley, said on Monday that the recent correction was just an "appetizer, not the main course."
Since global central banks have either started raising interest rates from historic lows, like the Fed, or tapering asset purchase programs that were introduced during the financial crisis as a way to stimulate growth, market jitters have grown over what will happen once there has been a complete withdrawal of central bank support that has boosted liquidity.
Watling said that while he believed equities were still in a cyclical bull market, declining liquidity was "dangerous."
"This has been the most heavily, liquidity-fueled bull market ever. So sniffing taking it away, which was perhaps what the correction was about in January, is quite a dangerous environment. I'd be very nervous, in the medium-term, about what happens when liquidity is withdrawn."
Not everyone is nervous about recent and forthcoming market activity. Martin Gilbert, co-CEO of multi-billion dollar fund Standard Life Aberdeen, said in early February that the recent fall in stock markets was just a "overdue and welcome" correction. He didn't think the sell-off had much further to go.