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The calmest markets in 20 years – and why that should make you nervous

Andrew Williams
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Lightning Storms Over Poole Harbour
Markets may be in the calm before the storm. Pictured: Poole Harbour (Source: Getty)

There are very few times in history where markets have been more calm. Andrew Williams, author on The Value Perspective blog, highlights why this should leave investors deeply concerned.

It may have become a cliché to describe the world as an uncertain place – especially over the last year or so – but clichés are clichés for a reason.

It would, for example, be a brave pundit who stuck their neck out and declared what President Trump will or will not do next or how things are going to play out between North Korea and its neighbours.

Closer to home, there is of course the small matter of the Brexit negotiations.

And while the issue of the French presidency may recently have been settled, other important elections have still to take place this year in Europe – on both sides of the channel.

In short, there are plenty of unpredictable forces at play across the world and yet, that being so, how can it be investment markets are as serene as they have been at almost any point in their history?

Why are markets so calm?

This Financial Times article, for example, offers some striking statistics on ‘volatility’ – the degree to which investment prices fluctuate. (In passing, we would point out that while the wider market tends to view volatility solely as a measure of risk, in reality it also reflects opportunity. Value investors thus look to take advantage of the sentiment and emotion that causes prices to swing more than is warranted by the cold facts.)

Anyway, the FT points out that, the day after “the expected but welcome French election victory of Emmanuel Macron”, the Vix index – which measures the short-term ups and downs of the main US equity market, the S&P500 – fell to its lowest level since 1993. Furthermore, since its inception in 1992, the Vix has only ever been lower on three other days. This is astonishing.

“Similar gauges of expected volatility in the currency and Treasury [bond] markets slid to their lowest levels since 2014,” the FT continues. “The actual, realised 90-day volatility of the S&P 500 index has fallen to just 6.7%, which makes this the most tranquil market since 1995”. Oh – and apparently the S&P 500 has enjoyed lower realised volatility in only 3% of trading days going all the way back to 1928.

Should we be concerned?

Perhaps, as many investors appear to be thinking, this really is a case of ‘Nothing to see here – move on’ although, on The Value Perspective blog, our own feeling is closer to: “It’s quiet out there – too quiet.” Or, as one professional investor told the FT: “When something happens, it’s going to be really bad … Volatility has become completely useless as a measure of risk.”

So what is happening here and why? It would appear many investors are now accepting as ‘normal’ the current market environment; ultra-low interest rates, abundant liquidity and central bankers willing to do “whatever it takes” to keep things on an even keel in the short term – often regardless of the longer-term consequences.

Yet, even at the start of last year, we were pointing out how unlikely such an environment would appear to most investors only a decade ago, adding: “Economist Hyman Minsky once wrote ‘The illusion of stability of the system will, over time, create its own instability’ and, on The Value Perspective, we would certainly argue the stability many equity investors have sought in so-called ‘bond proxy’ stocks is wholly illusory.”

Bond proxies are equities that are presumed to resemble bonds in terms of their ability to provide low-risk income, but with higher yields. Consumer staples or utilities stocks are examples.

More than a year later, the gap between the valuation of those bond proxy companies, which plenty of investors are still using as a comfort blanket, and everything else is growing wider and wider – as is the dislocation between the current market trajectory and the whole of the rest of history. And the fact that this situation cannot go on forever brings to mind one more cliché – "the calm before the storm".

Important Information: The views and opinions contained herein are those of Andrew Williams, Fund Manager, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. The sectors and securities shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell. This material is intended to be for information purposes only and is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide and should not be relied on for accounting, legal or tax advice, or investment recommendations. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. All investments involve risks including the risk of possible loss of principal. Information herein is believed to be reliable but Schroders does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in this document when taking individual investment and/or strategic decisions. The opinions in this document include some forecasted views. We believe we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. However, there is no guarantee than any forecasts or opinions will be realised. These views and opinions may change. Issued by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority.

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