All posts in category: Volatility (29)

For the Unbelievers

Friday, June 2nd, 2023

Low risk, not high return, makes Japanese equities attractive

Our proprietary volatility index dropped out of the danger zone three weeks ago, having warned us back in May 2022 that something was going to break. This helps to explain why investors feel so comfortable with equity risk at the moment. All equity regions have levels of realised volatility below their 25-year median and only US Treasuries are still in the danger zone. The volatility of Japanese equity returns is in the 13th percentile of its 25-year history. Investors don’t have to believe the new (or is it the old) shareholder activism story. The risk-cost of entry into Japanese equities is low by historical standards and that is enough to make the risk-reward calculations work.

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No Longer the Cornerstone

Friday, February 17th, 2023

Cash is the new risk-free asset

Using the word “risk-free” to describe an asset which has fallen by some 20% during the course of the last two years, would offend most ordinary users of the English language. But finance professionals are still happy to do this when talking about long-dated government bonds. 10-year US Treasuries have failed to hedge the decline in US equities and the same is true in the Eurozone. Worse still, tactical allocation models based on this relationship have under-performed their benchmarks, removing the possibility of generating any alpha from market timing. All these problems go away as soon as we use cash instead of government bonds. It has higher absolute returns than bonds in the US and the Eurozone and the new models outperform their benchmarks with lower drawdowns and better risk-adjusted returns. It’s time for a rethink.

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Normality Reasserts Itself

Friday, May 27th, 2022

Monetary policy distorted the mechanics of risk and return

The huge monetary interventions during the pandemic in the US and other countries were designed to protect equities from a surge in economic and financial risk. They succeeded, but at the cost of distorting the normal relationship between risk and return: specifically, the excess volatility vs the excess return of equities vs bonds. This is now reverting back to normal. As the volatility of equities rises relative to the volatility of bonds – and this figure is well below its long-run average, let alone its potential peak – their return relative to bonds must decline. The only developed market which may escape the worst of this adjustment is Switzerland.

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Something Is Going to Break

Friday, May 13th, 2022

Volatility has entered the danger zone.

Realised volatility continues to march higher every week and we have now got to the danger zone, where this creates the conditions for more volatility – especially if the FOMC is committed to much tighter monetary policy. In these circumstances, traditional valuation metrics lose a lot of their power and investors should assume that markets in one or more major asset classes will become disorderly. We think this has already begun in Nasdaq, Italian government bonds and the Chinese yuan. Other assets, which may follow in due course, include US High Yield, credit ETF’s and US housing.

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How to Hedge an Equity Sell-Off

Friday, September 18th, 2020

Not with government bonds

Bonds don’t always go up when equities go down. In 2003, holding long-dated government bonds offset 50% of average local currency losses in developed equity markets. That ratio has fallen steadily in each of the following major sell-offs, 2009, 2016 and 2020. This year, it was effectively zero on average for the seven largest developed markets. For some countries, it was negative – i.e. bonds went down just when you needed them most.

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Lessons from a Fast Market

Friday, June 12th, 2020

China plays a different game and Healthcare suffers

Yesterday’s sell-off was so brutal that it probably marks the start of a different regime in equity markets. We are out of Phase 1 of the recovery and into a second more sceptical and nervous regime. Both the US and the UK broke of out the uptrends in our daily indicator that have been in place since March. The technical situation is better in the Eurozone and Japan, while the level of financial repression is China so severe, in our view, that the indicator has lost most of its signalling power.

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One Disease; Three Themes

Friday, April 3rd, 2020

Consensus is looking for mean reversion in the wrong place

Three interesting ideas emerge from our regular reports. First, the volatility shock will almost certainly be as bad as 2008. Second, we believe that a long Technology /short Energy trade will have a positive pay-off no matter whether equity markets rise or fall. Third, our models are increasing exposure to EM Equities. We recognise this is a contrarian trade, but it is well-supported by our process and doesn’t depend on one or two countries.

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Asia: First In, First Out

Thursday, March 19th, 2020

Already producing better risk-adjusted returns

The recent volatility shock is as big as the one in the middle of the GFC and it isn’t over yet. It has also happened three times faster, in three weeks rather than nine. Fear is inevitable, but the are some interesting opportunities, especially in Asia. Countries like Taiwan and South Korea have managed the corona virus better than the US or Europe, while China is already recovering. If you wait for the bounce in the West, you may miss it in the East.
There

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EM Bonds: the new safe haven

Friday, March 6th, 2020

Higher yields and lower volatility

Many investors, brought up on the Tequila crisis of 1994, or the Thai baht crisis of 1997, or others too numerous to mention, may be surprised to see EM Sovereign Bonds at the top of our euro asset allocation model and at #2 in the US$ version. Times have changed. The volatility of the EM bond portfolio (but not necessarily individual countries) is less than 7-10 year Treasuries and the yield is a lot higher. They deserve their ranking.

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New Risk Conditions Indices

Thursday, October 10th, 2019

Equity and bond volatility are behaving inconsistently

This week we introduce four new risk conditions indices covering the equity and government bond markets of selected emerging market and developed countries. They highlight the fact that the relationship between equity and bond volatility is abnormal, given their recent relative performance.

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