Broker Check

Volatility Returns to Global Equity Markets

| February 07, 2018
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                                      Volatility reappeared in global equity markets following over a year of easy returns. All the recent volatility has been on the upside, and this correction should serve as a reminder to investors that volatility is a two-way street. We do not think it is the start of a severe bear market: the economy is too strong at this juncture. Nevertheless, this should serve as a warning to investors that risk assets can fall and to pay closer attention to downside risk. The VIX index, which measures market forecasts for volatility quintupled off the low. The MOVE Index, which measures volatility in the Treasury markets has risen about a third from its lows. Nobody can say for sure what triggered this, but speculators have been making handsome profits in cryptocurrencies and shorting volatility. Shorting volatility occurs when investors use options, ETFs or ETNs to bet that markets remain calm. Each month, they collect premiums unless markets fall significantly. When that occurs, speculators can lose a lot if not all their investment if the market moves too fast to the downside. This is what happened over the last few days and NPP believes that algorithmic trading has contributed greatly to the rapidity of the sell-off. Quantitative investors such as risk-parity funds and commodity trading advisors design trading and investing strategies based on mathematical patterns. When something changes in the inputs, it can force these funds to de-risk quickly causing flash-crashes as their models recalibrate. NPP, does not place all the blame on algorithms. Equities were overdue for a pullback as stocks were beginning to discount all the good news. Former Fed Chair Janet Yellen mentioned in a speech this weekend that she thought global equity markets were ahead of themselves. We suspect Chairman Powell is secretly happy that her speech wrung some of the excesses out of risk markets. It is notable to us that other indicators of a more serious economic backdrop are not coinciding with this pullback. Corporate credit spreads have not widened significantly, and the yield curve has steepened slightly recently after trending significantly lower for about a year. In short, this strikes NPP as a normal pullback that refreshes a still intact bull market for its next move higher. Looking ahead though, investors will need to remember, that equities can go down and valuations matters. We expected a pullback this year, although the rapidity and timing surprised us somewhat. Now that is has occurred, we still expect mid to high single digit returns for calendar 2018.

 

*The information presented in this newsletter is for educational purposes only. It is not intended to be considered investment advice, as there is no substitute for professional advice from a qualified adviser with knowledge of a given client's investment objectives and other circumstances. Past performance may not necessarily be indicative of future results.
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