The rise in vo­latil­ity

Financial Mirror (Cyprus) - - FRONT PAGE - Mar­cuard’s Mar­ket up­date by GaveKal Drago­nomics

First it was the for­eign ex­change mar­kets, then com­modi­ties, fol­lowed by fixed in­come mar­kets. Now it’s the eq­uity mar­kets. Wher­ever we look, vo­latil­ity has been creep­ing higher, not sur­pris­ingly. At the end of the US Fed­eral Re­serve’s first round of quan­ti­ta­tive eas­ing, and at the end of QE2, the mar­kets wob­bled. So, with QE3 now wind­ing to a close (and with the ECB still be­hind the curve), a pe­riod of un­cer­tainty and fraz­zled nerves should prob­a­bly have been ex­pected.

Nonethe­less, view­ing the re­cent mar­ket moves solely through the lens of cen­tral bank ac­tion (or in­ac­tion) may be overly re­duc­tive. After all, one can look at mar­kets through five dif­fer­ent prisms.

- Growth: Apart from the US, which seems to be hum­ming along, most of the re­cent eco­nomic data has dis­ap­pointed. This is es­pe­cially true in Europe and Ja­pan, while China, fol­low­ing Beijing’s mini-stim­u­lus this spring, is again un­der­shoot­ing ex­pec­ta­tions. Worse still, there are few rea­sons to ex­pect Chi­nese, Ital­ian, French or Ger­man growth to re­bound mean­ing­fully be­tween now and the end of the year. Then there are the emerg­ing mar­kets that face sig­nif­i­cant head­winds, in­clud­ing Rus­sia, South Africa, Brazil and Venezuela. All this con­trib­utes to a lack­lus­tre global growth out­look.

- Mo­men­tum: We touched on the de­te­ri­o­ra­tion of Euro­pean eq­ui­ties’ mo­men­tum ear­lier this sum­mer. Since then things have got worse, with the Eu­rostoxx in­dex down in nine of the 13 trad­ing ses­sions fol­low­ing the Euro­pean Cen­tral Bank’s an­nounce­ment of ABS pur­chases. Even more wor­ry­ing, neg­a­tive mo­men­tum, which un­til a few weeks ago seemed con­fined to Europe, now seems to be spread­ing. The Rus­sell 2000 is down for the year. So is Aus­tralia’s ASX, Malaysia’s KLCI, etc…

- Liq­uid­ity: Our own an­a­lysts ar­gue that signs of a tighter liq­uid­ity en­vi­ron­ment are grow­ing by the day, with credit spreads widen­ing, the US dol­lar ris­ing, the ECB’s TLTROs fail­ing, ran­dom cor­po­rates go­ing bank­rupt (phones 4U), and breadth de­te­ri­o­rat­ing rapidly in most eq­uity mar­kets.

- Be­havioural fi­nance: The thrust of our work on be­havioural fi­nance is the no­tion that roughly two thirds of the time, a given mar­ket will act ‘nor­mally’. The pat­tern of in­di­vid­ual stocks within the in­dex will be broadly chaotic and driven by many dif­fer­ent fac­tors: oil stocks will move with oil prices, banks will be af­fected by changes in the yield curve, etc. Then, one third of the time, mar­kets will move into ‘ab­nor­mal’ state, when all stocks be­come cor­re­lated, with their per­for­mance driven by one fac­tor, usu­ally yes­ter­day’s share price. In such an en­vi­ron­ment, adding value through stock­pick­ing be­comes almost im­pos­si­ble (but trend-fol­low­ers thrive). An in­creas­ing num­ber of mar­kets are now show­ing ‘ab­nor­mal’ be­hav­iour on our be­havioural fi­nance ma­tri­ces.

- Val­u­a­tions: This is the big de­bate. With in­ter­est rates at zero, one can ar­gue that eq­ui­ties ev­ery­where re­main mas­sively un­der­val­ued, even though val­u­a­tions in a num­ber of mar­kets (not least the US) are start­ing to look rich on a his­tor­i­cal ba­sis. More­over, one can also ar­gue that while an over­all mar­ket (China, say, or Europe) may look un­der­val­ued, the un­der­val­u­a­tion is the re­sult of deep dis­tress in a num­ber of sec­tors (SOEs in China, banks/util­i­ties/tele­coms/oil in Europe…).

Putting it all to­gether, it is hard to es­cape the con­clu­sion that the en­vi­ron­ment for stocks is turn­ing ugly: global growth is dis­ap­point­ing, liq­uid­ity and mo­men­tum de­te­ri­o­rat­ing, and mar­kets are start­ing to act ab­nor­mally. When you con­sider that Septem­ber and Oc­to­ber are of­ten chal­leng­ing for eq­uity in­vestors’ nerves, per­haps we should not be sur­prised by the re­cent wave of profit-tak­ing.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.