MARKET RISK REPORT Earthquakes

Transcription

1 MARKET RISK REPORT Earthquakes November 2018

2 Executive summary Volatility changes were all upwards on the month, outside FX. Asset volatilities were almost all high relative to their 12-month averages, although FX was low or medium. Realised volatility (of the Eurostoxx index over 30 days) rose from 10.8% to 15.5% (medium up to high). Equity market price moves were strongly negative. Volatility trends were all upwards. Sector volatilities ended at 17-33% and were all high relative to the last 12 months. Sovereign bond price moves were small. Volatility moves were all upwards, ending at just 1-4% (Italy at 10. though). All were medium or high. FX moves were upwards against the euro. Volatility moves were downwards and ended at 5-6%. Volatilities relative to the euro were all low or medium. Option volatility will probably have been very high, as underlying price moves during the month were large, and volatility of volatility was strongly up e.g. to 213% for the US (high). Commodities price moves were once again large. Volatility moves were mixed e.g. Oil up to 26.6% (low). Real Estate (equity) price moves were again negative. Volatility moves were upwards and finished at 13-2 (all medium or high). PE Funds and hedge funds fell, with volatilities up. Niall O Connor

3 Table of contents 1. Summary volatility matrix p Key News p Kurtosis & correlation in the equity markets p Equities p Equity Implied Volatility p Fixed Income p Foreign Exchange p (Equity) Options p Commodities p Real Estate (Real Estate Share Prices) & Alternatives p

4 Summary volatility matrix and outlook Another month of rising bond yields continued to put pressure on equity valuations. Three month US treasury bills (as about as risk free an asset as you can find) yielded more than core inflation in the US for the first time since In the intervening period investors in cash have been penalised 1.5-2% annually by inflation. Now, once again, investing in (USD) cash generates a positive real return. This continues our theme of QE switching to QT; QE s purpose was to force money out of risk-free assets (by reducing their yields and so making them less attractive) and into more risky assets. QT, definitionally, should do the opposite. As QT progresses, we should see the riskiest assets (high growth, but loss-making companies) sell off the most. There should be a movement of money from high growth equities to value equities (a reversal of a years-long trend) and finally into risk-free assets. We saw the beginnings of this process during October, but the tectonic plates of QT are likely to continue to drift, with occasional earthquakes. ASSET CLASS EQUITIES VOLATILITY OF VOLATILITY GOVERNMENT BONDS FX VS $ COMMODITIES PROPERTY ALTERNATIVES KURTOSIS CORRELATION AREA North America LATEST VOLATILITY LATEST Z-SCORE REGIME 22.6% 1.9 high Asia ex-japan 21.8% 2.7 high Europe 14.9% 1.6 high Japan (Nikkei) 24.9% 2.0 high Energy 21.6% 1.7 high Consumer Staples 12.7% 1.3 high Financials 16.8% 1.6 high IT 32.7% 2.8 high Volatility of VIX 213% 0.7 high Volatility of VSTOXX 123% -0.1 medium Germany 4.2% 0.4 medium US 3.9% 1.2 high Japan medium Italy high /$ 5.3% -1.4 low /Yen 6.2% -0.8 low /CHF 4.2% -0.3 medium / 5.4% -0.2 medium Oil (Brent) 26.6% 0.7 high Gold 13.6% 1.8 high Copper 15.7% -1.0 low US high Europe 17.8% 2.1 high Japan 12.9% 0.4 medium HFRX Global HF 5.1% 1.7 high Avg PE Fund 11.5% 2.5 high ZCF 1% left (vs for normal curve) low Average market correlation with euro equities 26% 0.4 high Note: Throughout the text we refer to volatilities as being "low", "medium" or "High". We define this by defining three equal "sized" regimes over the last 12 months. i.e. High volatility implies that volatility is in the upper third of its statistical range over the last 12 months. The table shows the "z-score" of the volatility of each market, i.e. how many standard deviations above (or below) the mean over the last 12 months each market's volatility is. 4

5 Key News Major Volatility-Driving Events Newsflow was surprisingly light for the time of year, but was overshadowed by the sharp downward moves in equity markets. Italy s government proposed a 2.4% deficit, putting it on a collision course with the EC Polls in Bavaria weakened Angela Merkel s position. She announced she would stand down as leader of her party in December The right-wing ex-army captain Jair Bolsanaro was elected president of Brazil Stock markets had a difficult month, with fears over a trade war as well as higher interest rates; the US ten year bond yield reached a new post-2011 high. Almost all major markets were down on the year at one point. Despite a late rally, the NASDAQ was down -9% on the month Shares in Jaguar Landrover s parent company and VW fell on falling demand, especially from China Sears filed for bankruptcy US banks reported strong Q3 earnings. Prices of asset managers continued to fall as price competition increased and inflows slowed or reversed There was surprisingly little major M&A: Calsonic Kansai bought Magneti Marelli for $7bn. IBM bought Red Hat for $34bn Pakistan was forced to take an IMF loan, as well as $6bn from Saudi Arabia The US budget deficit increased to 3.9% in the year to end September, despite strong Q2 and Q3 GDP growth of 4.2% and 3.5% Eurozone growth slowed to 1.7% in Q3, while inflation rose to 2.2% UK wages rose by 3.1%, faster than inflation which fell to 2.4% The Chinese central bank stimulated the economy with $100bn through reducing bank reserve requirements. The economy grew at 6.5% in Q3, the slowest growth since 2009 and Yuan fell to close to 7 against the Dollar % % 1. The Turkish Lira continued to slide as the government announced tax cuts despite the budget deficit UK GDP growth defied the Brexit-related gloom to record +0.7% in the 3 months to August 2018 GDP estimates for developed countries were unchanged. GDP ESTIMATES FOR 2018, DEVELOPED COUNTRIES 0.5% Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 8% 7% 6% 5% 4% 3% 2% 1% US UK Spain Germany Euro Area Japan France Italy 2018 GDP growth forecasts for developing countries were also unchanged. GDP ESTIMATES FOR 2018, DEVELOPING COUNTRIES Mar-17 Jun-17 Sep-17 Dec-17 Mar-18 Jun-18 Sep-18 Dec-18 China India Turkey Russia Brazil 5

6 Kurtosis Correlation in the equity markets Both tails moved from hard left back towards normal. The left tail ended at vs theoretical and the right tail at just vs Cornish-Fischer expansion of Eurostoxx50 (60 days) The left tail ended at vs theoretical and the right tail at just vs ZCF 1% left Z 1% left ZCF 1% right Z 1% right Methodology To capture a measure of both Skewness and Kurtosis we look at the Cornish-Fischer expansion, which gives a good measure of the tails of the equity market. (We use a 60-calendar day rolling basis). The underlying market we plot is the Eurostoxx 50, but other equity markets normally show very similar results. We plot on the chart the expected Z-scores for 1% left tail (i.e. a 99% VaR) and a 1% right tail assuming a normal distribution: +/ We also show the Cornish-Fischer expansion result for the same market. This indicates how far from a normal distribution each tail was. On a long term basis on average the tails are slightly fatter than the normal distribution would suggest, which should not come as a surprise. What is perhaps more surprising is how much variation in fat-tailedness there has been: a daily 99% VaR has varied between -1 and -4.5 standard deviations over time. The biggest variations from +/-2.33 came in 2008, 2010 and

7 Inter-market correlations with EU equities Inter-market correlations (60 days) 26% AVERAGE CORRELATION North America Japan Bunds (negative) /$ Average Average correlation fell to just 26% (high), as /$ correlation switched to negative. Multi-asset portfolio volatility 15% 1 5% -5% -1 Average asset Multi-asset portfolio Diversification impact 7% AVERAGE VOLATILITIES Average asset volatility rose from 7.4% to 14.4%, while the benefit of (multi-asset) diversification also increased to (6.9%). In combination portfolio volatility rose from 3.8% to 7.5%. 3.7% PORTFOLIO VOLATILITY Note: The chart shows 30-day correlation over time between different markets and the pan-euro equity market. Higher levels of correlation will in general lead to less ability to diversify risks, and higher portfolio volatility for given position holding volatility. 7

8 Equities Stock price STOCK PRICE PERFORMANCE: REGIONS (LOG SCALES) ,000 24,000 23,000 22, % Europe , , ,000 North America Europe Asia ex-japan Japan (rh axis) Major equity indices price moves were strongly negative everywhere. The Nikkei was -9.1%, North America was -7.1%, Europe was - 5.5% to a new 12-month low, and Asia ex-japan was down once more, at -9.9% and again hit a new 12-month low during the month. STOCK PRICE PERFORMANCE: SECTORS (LOG SCALES) Energy Consumer Staples IT Financials, rh axis Sector price move dispersion was once again high. IT was -8.7%, Financials were -6.7%, Consumer Staples were - 1.6%, while Energy was -10.1% on a weakening of both the oil price and equity valuations % FINANCIALS 8.7% IT 10.1 % ENERGY 1.6% CONSUMER STAPLES 8

9 Equities Volatility EQUITY VOLATILITY: REGIONS 25% 2 15% 1 5% North America Europe Asia ex-japan Japan (Nikkei) 14.9%EUROPE Regional volatility moves were sharply upwards, ending at close to 12 month highs. North America rose to 22.6% (low up to high), Asia ex-japan rose to 21.8% (high), Europe rose to 14.9% (medium up to high) and Japan (Nikkei) rose to 24.9% (low up to high). EQUITY VOLATILITY: SECTORS 35% 3 25% 2 15% 1 5% Energy Consumer Staples IT Financials Sector volatility moves were also all upwards. Energy rose to 21.6% (low up to high), Consumer Staples rose to 12.7% (medium up to high), Financials rose to 16.8% (medium up to high) and IT rose very sharply to 32.7% (low up to high) 9

10 Equity Implied Volatility Market-Implied Near Term Outlook Implied Volatility Implied volatility rose, but more gradually than the sharp moves in stock markets would suggest. The VIX rose from 12.1 to 21.2, while European implied volatility (VSTOXX) rose from 14.8 to 20.3 on the month.. IMPLIED VOLATILITY VIX VSTOXX 25 0 VSTOXX VIX Implied vs Realised Volatility (European equity) implied volatility rose, as did realised volatility. The ratio of implied/realised therefore remained relatively steady, falling just slightly to 131%. This ratio remains only slightly above a neutral level, suggesting that the market did not expect there to be further volatility-inducing news over the next 30 days compared to the last 30 days. IMPLIED VS. REALISED VOLATILITY 4 35% 3 25% US tax reform (Nov) Inverse VIX (Jan) Italy, Germany politics (May) China bear market (Jul) VOLATILITY 131%IMPLIED/REALISED % % Trade wars (Feb) Italy (Sep) 5 - Implied Realised Implied / Realised (rh axis) Note: Note: the implied/realised volatility ratio gives an indication as to whether the market sees an event in the next 30 days (the implied volatility period) which will increase realised volatility (implied/realised >10, e.g. within 30 days prior to the Greek elections during the Greek crisis) or a period of relative calm after high realised volatility (implied/realised <10, e.g. immediately after Draghi s calming whatever it takes comments). 10

11 Fixed Income 10-Year Government Bond Futures PRICES OF 10Y BOND FUTURES Prices Government bond price moves were small on the month; as with the early 2018 turbulence bonds were much less impacted than equities. German bonds rose +0.9%, US bonds fell -0.3%; and Japan rose +0.4% Germany US Japan Italy 10 YEAR BOND SPREADS OVER GERMANY, % The focus in European government bonds remained on Italy. Italian spreads over Germany finished up at 3., hitting a new post-eurozone crisis high of 3.1%. Spanish bonds by contrast remained around 1% over German Spain Italy VOLATILITY OF 10Y BOND FUTURES 12% 1 8% 6% Volatility moves were all upwards on the month. Germany rose to 4.2% (low up to medium), US rose to 3.9% (low up to high), Japan rose to 1. (low up to medium) while Italy rose to 10. (high) 4% 2% Germany US Japan Italy 11

12 Foreign Exchange 3.1 % vs. 2.6% $ vs. 0.4% vs. Prices Most currencies rose back vs the euro. The Yen rose +3.1%, the dollar continued its positive run with +2.6%, and sterling strengthened by +0.4% as further progress was made towards Brexit FX RATES VS /$ /JPY /100 / (rh axis) 1.00 Volatility FX volatility moves reversed last month s upward trend and all fell, converging at 5-6%. /$ fell to 5.3% (medium down to low), /Yen fell to 6.2% (medium down to low), and / fell to 5.4% (medium). 5.3% vs. $ 5.4% vs. 2.6% vs. 12% 1 8% 6% 4% 2% VOLATILITY OF FX RATES VS. / /Yen /$ Note: The charts show currencies vs. the. Axes on the first chart are inverted to show conventional currency quotations, but with higher on the chart representing a stronger currency vs. the euro. 12

13 (Equity) Options Option volatility is mainly driven by the volatility of volatility and moves in prices of the underlying instruments affecting options deltas. Volatility of Implied Volatility Volatility of implied volatility rose again. Volatility of the VIX rose to 8 (medium down to low), and volatility of the VSTOXX fell to 81% (medium down to low). Volatility of VIX rose to 213% (low up to high), while Volatility of VSTOXX rose to 123% (low up to medium). VOLATILITY OF VOLATILITY US % EUROPE 25 Volatility of VIX Major (Regional Equity) price moves Volatility of VSTOXX (Equity) price moves were very large and negative in all regions. Price moves are very likely to have been drivers of option volatility. CHANGE IN PRICES OF EQUITY INDICES, 30 DAYS 15% 1 5% -5% -1-15% North America EU Asia ex-japan Japan Note on Treatment: Options show more complex behaviour than the other instruments we look at in this report, so we make some simplifying assumptions. As Calls and Puts are in effect polar opposites and in and out of the money options behave very differently, it is hard to generalise all options behaviour. However, we look at the two key drivers: volatility of implied volatility and major price movements of the underlying security. Implied volatility (via an option's Vega) drives option prices, so a big indicator of option price volatility is the volatility of implied volatility. But usually the biggest driver of individual option prices is the movement of the underlying (via the option Delta): a move in either direction will cause the option to go more in or out of the money (and a corresponding change in the option s Delta and price volatility). As a proxy for this, we look at the 30-day price swing of equity market indices; options on bonds or FX could of course behave differently. The 30-day period is relatively close to the time to maturity of many options. Calls and Puts will respond in opposite fashions: calls becoming more volatile (relative to the size of the underlying notional) as prices rise. 13 Note on Convertibles: Convertibles are in effect a combination of a bond and a call option, with the bond portion usually making little contribution to the instrument volatility unless the option is significantly out of the money. As such, convertible portfolios volatilities will tend to behave similarly to call option portfolios, and this commentary can be applied to convertibles as well as options.

14 -8.8% OIL Commodities Prices Commodities again saw some big price moves. Gold rose +2., but Copper fell, down -5.2%, and Oil fell by -8.8%. Iron ore continued to rise, in contrast to the bearishness over the Chinese economy. 2. GOLD COMMODITIES PRICES, $ -5.2% COPPER ,800 1,600 1,400 1,200 1, Volatility Oil (Brent) Copper (indexed) Iron Ore Gold (rh axis) Volatility moves were mixed. Oil (Brent) rose to 26.6% (low up to high), Gold rose to 13.6% (low up to high), while Copper fell again to 15.7% (high down to low). COMMODITIES VOLATILITY 4 35% 3 25% 2 15% 1 5% Oil (Brent) Copper Gold Note: all prices refer to near futures rather than spot with the exception of iron ore which is a spot price. 14

15 Real Estate and Alternatives (Real Estate Share Prices) REAL ESTATE (REIT) PRICES 2,300 2,250 2,200 2,150 2,100 2,050 2,000 1,950 1,900 1,850 1,800 3,400 3,300 3,200 3,100 3,000 2,900 2,800 2,700 2,600 2,500 2, % EUROPE -2.4% US Real estate equities price moves were again negative on the month. The US fell by -2.4%, Europe was -3.2%, and Japan was -3.1%. -3.1% JAPAN Europe Japan (rh axis) US (rh axis) REAL ESTATE (REIT) VOLATILITY 25% 2 15% 1 5% Europe Japan US Volatility moves were strongly upwards the month. US rose to 20. (medium up to high), Europe rose to 17.8% (low up to high) and Japan rose to 12.9% (low up to medium). Note: Note that for property we look at indices of the share prices of REITs, and not the underlying property directly, for which little real-time data is available. This is usually consistent with funds which tend to invest in property indirectly, e.g. via REITs or property companies. As REITs are usually focused on commercial property, residential property may also follow a slightly different pattern to that discussed in this article. 15

16 Alternatives ALTERNATIVES PRICES 1,060 1,040 1,020 1, Global Hedge Funds (EUR) Avg PE Fund (indexed) UK listed PE funds fell -3.4%, while the average hedge fund was down -4.1% on the month. 14% AI VOLATILITY 12% 1 5.1% HFRX volatility 8% 6% 4% 2% 11.5% AVERAGE PE FUND Global Hedge Funds (EUR) an average PE fund Volatility of the average hedge fund rose to 5.1% (low up to high) and an average PE fund rose to 11.5% (high). 16

17 Definitions To avoid repetitions, the term volatility refers to annualised, 30-day average realised volatility in local currency unless otherwise specified. As such, it may be lower than, and lag, shorter-term market volatility in times of high market volatility. Charts show data up until 30 st September 2018, and news and events are included up to that date. The commentary was written on or before 9 th October Disclaimer The commentary does not constitute, and is not intended to constitute, investment advice. Any views expressed in this report are based on historical market data and as such cannot be interpreted as being forward-looking, or to constitute forecasts. Past movements are not necessarily indicative of future movements. Employees of IRML/ARKUS FS may hold positions in securities mentioned. All expressions of opinion reflect the judgment of IRML/ARKUS FS at this date and are subject to change. Information has been obtained from sources considered reliable, but we do not guarantee that the report is accurate or complete. This document is not for US clients or distribution to the US Arkus Financial Services Arkus is the brand under which IRML S.A. operates and provides services. This document is the property of IRML/Arkus FS and should not be copied or distributed to any third party without the prior consent of IRML/Arkus FS please contact us regarding distribution rights.

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