MARKET RISK REPORT Inflection

Transcription

1 MARKET RISK REPORT Inflection February 2019

2 Executive summary Volatility changes were mostly downwards on the high levels of December, outside FX and Government Bonds. Asset volatilities were almost all medium to high relative to their 12-month averages. Realized volatility (of the Euro Stoxx50 index over 30 days) fell from 19.0% to % (high down to medium). Equity market price moves were sharply positive. Volatility trends were upwards. Sector volatilities spanned a range of 11-26% and were medium relative to the last 12 months, except for Information Technology that is still in a higher volatility regime. Sovereign bond price moves were strongly positive in Germany and the US with a small decline in Japan and Italy. Volatility trends showed a mixed picture. Germany and the US increased in volatility and are now in a medium and high volatility regime, 3.9% and 4.8% respectively. Italy and Japan were unchanged at high and low regimes, 5.1% and 1.1% respectively. FX moves were up against the euro, with the pound gaining 2.9% Volatility moves were all upwards and ended at 5-8%. Volatilities relative to the euro were all high with the exception of the Swiss Franc which increases from low to medium. Option volatility will probably have been low, as underlying price moves during the month were very moderate, and volatility of volatility changed from a medium to a low regime. Europe decreased from 160% to 80% and the US decreased from 154% to 113%. Commodities price moves were moderate, but with steady and significant. Volatility moves were mixed e.g. Oil decreased from 54% to 30% (still medium), Copper increased from 20% to 23% (medium up to high) and Gold largely unchanged at 8% (low). Real Estate (equity) price moves were sharply up, steadily recovering all losses during December. Volatility moves were down and finished at 11-15% (Japan unchanged at high, US and Europe down from high to medium). PE Funds and hedge funds showed steady but strong gains with a decrease in volatility (from high to low) for the average hedge fund (2.7%) and a still a high volatility regime for the average PE fund (11.7%). The Arkus Risk Team

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 January has offered investors some respite as markets rallied and risk assets made up most of their losses in an almost V-shaped recovery. The Fed dovish rhetoric on both the future path of interest rates and the balance sheet reduction plan has quelled any fears of tighter monetary policy. This takes away a key headwind (for now), but the risk remains to the downside with global economic growth stalling and little relief on political uncertainty such as US-China Trade talks and Brexit. What was somewhat unusual is that bond markets rallied too. So, the market outlook appears to be mixed and nearing an inflection point. Where are we in the business cycle? Are we still in a late-cycle phase or are we entering an end-cycle phase? With QT on hold, the current expansion could be stretched and risk assets could continue to outperform, as they have done historically in late-stage cycles. In our view, something has got to give and we should prepare for a bumpy ride. ASSET CLASS EQUITIES VOLATILITY OF VOLATILITY GOVERNMENT BONDS FX VS $ COMMODITIES PROPERTY ALTERNATIVES KURTOSIS CORRELATION AREA North America LATEST VOLATILITY LATEST Z-SCORE REGIME 17.9% 0.4 medium Asia ex-japan 14.8% 0.2 medium Europe 12.8% 0.2 medium Japan (Nikkei) 15.8% -0.3 medium Energy 18.6% 0.1 medium Consumer Staples 10.8% 0.2 medium Financials 13.8% 0.2 medium IT 26.4% 0.7 high Volatility of VIX 113% -0.5 low Volatility of VSTOXX 80% -1.0 low Germany 3.9% 0.1 medium US 4.8% 2.1 high Japan 1.1% 0.5 high Italy 5.1% -1.0 low /$ 7.6% 1.1 high /Yen 8.2% 0.7 high /CHF 4.8% 0.3 medium / 8.0% 1.7 high Oil (Brent) 30.2% 0.2 medium Gold 8.0% -1.0 low Copper 23.0% 0.9 high US 15.2% -0.1 medium Europe 11.4% 0.0 medium Japan 14.1% 0.5 high HFRX Global HF 2.7% -1.0 low Avg PE Fund 11.7% 1.9 high ZCF 1% left (vs for normal curve) high Average market correlation with euro equities 21% -0.6 low 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 FED chairman Jerome Powell said the central bank will be patient in raising rates and would not hesitate to change balance sheet reduction plan if it was causing problems, quelling fears of tighter monetary policy in the near future. President Donald Trump blinked and agreed to end the government shutdown whilst not securing funding to build a wall on the Mexican Border. US-China trade talks are showing little progress with probably no meeting between President Donald Trump and President Xi Jinping before the March 2 deadline. German slow down: the economy shrank in the third quarter of 2018 and probably grew only slightly in the further. Over the year as a whole, GDP grew by 1.5%, down from 2.2%. Turkey inflation rate crept up to 20.4% in January. India central bank cut its key interest rate by a quarter of a percentage point, to 6.25%. French ambassador to Italy was recalled. 2nd and 3rd biggest economies have perhaps the worst relationship since ww2. France s Gilets Jaunes protests continued with no signs of improvement, despite Macron s start of a grand national debate. The Brexit deal was voted down with a large majority. Theresa May survived another vote of no-confidence and is now tasked with going back to Brussels and negotiate a more favorable deal. In particular, the Irish backstop needs to be replaced. China s central bank injected 570bn yuan (USD 84bn) into the banking system. China trade data was worse than expected: exports fell by 4.4% in December and imports by 7.6% Venezuela s political crisis is reaching boiling point amid growing efforts by the opposition to unseat the socialist president, Nicolás Maduro. European s competition commissioner blocked the merger between Alstom with the rail operations of Siemens. Ryanair reported the first quarterly loss since At the same time Germania, Berlin-based discount airline, declared bankruptcy. The election in Thailand was postponed. Thai Officials promised elections would take place before May and democracy would be restored. Newmont agreed to buy Goldcorp in a 10 USD bn deal. Combined the company will be the world s biggest gold miner. The US has filed criminal charge against Huawei, escalating its fight against the Chinese tech giant. In addition, allegations of violating Iran sanctions, Huawei is now accused of trying to steal trade secrets from T-Mobile. Jack Bogle, founder of Vanguard and father of index investing, died at the age of 89. Google was fined EUR 50 million by the French data-protection Office, the first penalty against a big tech firm for breaching the EU s General Data Protection Regulation (GDPR). The IMF cut its world economic growth outlook to 3.5% in 2019 and 3.6% in 2020, down 0.2% and 0.1%. The EU has slashed economic growth forecasts for Across the eurozone growth is expected to slow down from 1.9% to 1.3%. In particular, Italy (1.2% to 0.02%) and Germany (1.8% to 1.1%) were impacted the most. The UK is also expected to slow down significantly (1.7% to 1.2%). GDP ESTIMATES FOR 2019, DEVELOPED COUNTRIES GDP ESTIMATES FOR 2019, DEVELOPING COUNTRIES 5

6 Kurtosis Correlation in the equity markets The left tail was largely unchanged and remains significantly away from theoretical normality indicating that tail risks are to the downside. The right tail was also largely unchanged, with behaving almost exactly normal. The left tail ended at vs theoretical and the right tail at vs Cornish-Fischer expansion of Eurostoxx50 (60 days) The left tail ended at vs theoretical and the right tail at+2.42 vs 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 (with EU equities) 21% AVERAGE CORRELATION Average correlation further decreased from 24% to 21% (medium down to low) with /$ correlation becoming negative. However, North America Equity Market increased significantly, from 28% to 37%. Multi-asset portfolio volatility 12.0% AVERAGE VOLATILITIES We also look at a hypothetical multi-asset portfolio consisting of equities, bonds, gold, oil and hedge funds. Average asset volatility decreased sharply from 18.6% to 12.0%, while the benefit of (multi-asset) diversification largely unchanged at 5.2%. In combination, portfolio volatility decreased fractionally from 12.2% to 6.8%. 6.8% 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) +5.5% Europe January showed an almost V-shaped recovery with all regions recovering a good part of their losses. The Nikkei was +3.8%, North America was +8.3%, Asia ex-japan was +7.2%, while Europe was +5.5%. STOCK PRICE PERFORMANCE: SECTORS (LOG SCALES) Sector prices moved as expected with strong gains for most and moderate gains for more defensive industries (i.e. Consumer Staples). IT was +7.7%, Financials were +7.9%, Consumer Staples was +4.9%, while Energy was 10.3% on strong gains in oil prices. +7.9% FINANCIALS +7.7 % IT % ENERGY 4.9 % CONSUMER STAPLES 8

9 Equities Volatility EQUITY VOLATILITY: REGIONS 12.8 %EUROPE Regional volatility moves were down, entering into calmer waters the last week of the month. North America fell to 17.9% (medium), Asia ex-japan mostly unchanged at 14.8% (medium), Europe fell to 12.8% (medium) and Japan (Nikkei) fell to 15.8% (medium). EQUITY VOLATILITY: SECTORS Sector volatility moves were also very significant and all downward. Energy fell to 18.6% (medium), while Consumer Staples fell to 10.8% (medium), Financials fell to 13.8% (medium) and IT fell to 26.4% (still high). 9

10 Equity Implied Volatility Market-Implied Near Term Outlook Implied Volatility Implied volatility fell as stock markets rose. The VIX fell from 25.4 to 16.6, with European implied volatility (VSTOXX) falling from 23.9 to 15.1 on the month. IMPLIED VOLATILITY 16.6 VIX 15.1 VSTOXX Implied vs Realised Volatility (European equity) implied volatility fell, so did realised volatility. As realised volatility fell less than implied volatility, the ratio of implied/realised fell slightly, ending at 102%. This ratio is almost exactly at a neutral level, suggesting that the market does not expect further volatilityinducing news over the next 30 days compared to the last 30 days. IMPLIED VS. REALISED VOLATILITY 102%IMPLIED/REALISED VOLATILITY 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 >100%, 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 <100%, 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 moderate but up across the board as increased concerns over global economic growth appear to be making bonds more attractive relative to equities. German bonds rose +1.3%, US bonds rose +0.4%; and Japan rose +0.1%. 10 YEAR BOND SPREADS OVER GERMANY, % Italian spreads over Germany finished at 2.5%, down from a post-eurozone crisis high of 3.1% and 2.9% in November. Spanish bonds, by contrast, remained around 1.2% over German. VOLATILITY OF 10Y BOND FUTURES Volatility moves were mixed during the month. Germany fell to 2.8% (low), US rose to 3.1% (low up to medium), Japan rose to 1.5% (medium up to high) and Italy fell to 5.7% (medium down to low). 11

12 Foreign Exchange 0.8 % vs. -1.2% $ vs. 2.9% vs. Prices Currency moves were negative vs. the euro. The Yen rose +0.8%, the dollar was unchanged with 0.02% and sterling rose by 2.9%% on the increase likelihood of extending the Brexit deadline. FX RATES VS. Volatility FX volatility moves were all upwards and ended at around 8%. /$ rose to 7.6% (low up to high, /Yen rose to 8.2% (low up to high) and / rose to 8.0% (high). 7.6% vs. $ 8.0% vs. 8.2% vs. VOLATILITY OF FX RATES VS. 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. Implied volatility Volatility of implied volatility dropped back. Volatility of VIX fell to 113% (medium down to low) and Volatility of VSTOXX fell to 80% (medium down to low). VOLATILITY OF VOLATILITY 113% US 80% EUROPE Major (Regional Equity) price moves (Equity) price moves strongly positive over the month with the S&P 500 marking the best January performance since Price moves are very likely to have been drivers of option volatility. CHANGE IN PRICES OF EQUITY INDICES, 30 DAYS 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. 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. 13

14 15.0% 3.0% OIL GOLD Commodities Prices Commodities once again saw some big price moves. Oil rose +15.0% on hopes for China stimulus and supply cuts by OPEC and Russia, but is still substantially lower compared to a year ago. Copper rose +5.8% and Gold rose +3%. Iron Ore rose % and is now at multi-year highs following heightened concerns about supply disruptions. COMMODITIES PRICES, $ 5.8% COPPER Volatility Volatility moves were mixed. Oil (Brent) fell to 30.2% (high down to medium), Gold fell to 8.0% (low), and Copper rose to 23% (medium up to high). COMMODITIES VOLATILITY 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 11.5% EUROPE 10.3% US Real estate equities price moves were all significantly up on the month. The US rose +10.3%, Europe rose +11.5%, and Japan rose +5.7%. 5.7% JAPAN REAL ESTATE (REIT) VOLATILITY Volatility moves were all sharply down compared to the previous month. Moves in the US and Japan were small and steady, returning to the average range of the past year. The US fell to 15.2% (high down to medium), Europe fell to 11.4% (high down to medium), and Japan fell to 14.1% (still high). 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 UK listed PE funds rose +3.6%, while the average hedge fund was up +1.8% on the month. AI VOLATILITY 2.7% HFRX volatility 11.7% AVERAGE PE FUND Volatility of the average hedge fund fell to 2.7% (high down to low) and an average PE fund was slightly up at 11.7% (still 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 November 2018, and news and events are included up to that date. The commentary was written on or before 9 th December 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 This document is the property of Arkus FS and should not be copied or distributed to any third party without the prior consent of Arkus FS please contact us regarding distribution rights. 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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