Thursday 18 May 2017 12:51 pm Schroders Talk

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

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I’m an investment specialist on the equity value team at Schroders and an author on The Value Perspective.

I’m an investment specialist on the equity value team at Schroders and an author on The Value Perspective.

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".

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