MARKET RISK REPORT Just a Glitch?

Transcription

1 MARKET RISK REPORT Just a Glitch? January 2019

2 Executive summary Volatility changes were mostly upwards on the moderate levels of November, outside FX. Asset volatilities were almost all high relative to their 12-month averages. Realised volatility (of the Euro Stoxx50 index over 30 days) rose from 12.6% to 19.0% (medium up to high). Equity market price moves were sharply negative. Volatility trends were upwards. Sector volatilities spanned a range of 13-32% and were all high relative to the last 12 months. Sovereign bond price moves were all positive but volatility trends showed a mixed picture. Volatility trends were either stable or slightly upwards with the exception of Italy and Japan. The former decreased from 7% to 5.7% (back to a low regime) whereas the latter increased from 0.8% to 1.5% (entering a high volatility regime). FX moves were slightly downwards against the euro. Volatility moves were downwards and ended at 3-6%. Volatilities relative to the euro were all low with the exception of the British Pound which is still considered to be in a high volatility regime. Option volatility will probably have been very high, as underlying price moves during the month were again large, and volatility of volatility was still moderate e.g. 154% for the US (unchanged at medium). Commodities price moves were once again large. Volatility moves were mixed e.g. Oil increased even further from 41% to 54% with Gold and Copper reducing in volatility. Real Estate (equity) price moves were sharply down. Volatility moves were upwards and finished at 14-27% (all high now). PE Funds and hedge funds fell again, with a high volatility regime. 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 The occasional earthquakes anticipated in our November newsletter came without much delay and hesitation. Global markets showed sharp declines with many markets down double digits. The US equity markets booked their worst year since the financial crisis and the worst December since the Great Depression. To illustrate, the S&P 500 index fell 9.2% during the month. It is not a surprise then that volatility, both realized and implied, spiked. Investors looking for a silver lining might want to focus on the highly anticipated Powell put that has gotten more traction. After hiking rates in mid-december, The Fed Chairman recently said that he was listening very carefully to financial markets and would balance the steady flow of strong economic data against the potential of an array of risks. So far markets are not pricing in the anticipated two rate hikes in 2019 and markets even consider the Fed more like to cut rates instead. In our view, the recent change in risk appetite is there to stay and pausing the tightening of monetary policy is not likely to quell the current worries about global economic growth. To reference president Donald Trump: just a Glitch? Unlikely. ASSET CLASS EQUITIES VOLATILITY OF VOLATILITY GOVERNMENT BONDS FX VS $ COMMODITIES PROPERTY ALTERNATIVES KURTOSIS CORRELATION AREA LATEST VOLATILITY LATEST Z-SCORE REGIME North America 27.0% 2.0 high Asia ex-japan 14.6% 0.2 medium Europe 19.0% 2.3 high Japan (Nikkei) 30.1% 2.3 high Energy 25.0% 1.9 high Consumer Staples 13.4% 1.3 high Financials 19.0% 1.8 high IT 31.7% 1.7 high Volatility of VIX 153.9% 0.0 medium Volatility of VSTOXX 160.5% 0.4 medium Germany 2.8% -1.1 low US 3.1% -0.2 medium Japan 1.5% 2.1 high Italy 5.7% -0.7 low /$ 5.8% -1.0 low /Yen 6.4% -0.5 low /CHF 3.4% -1.0 low / 6.3% 0.6 high Oil (Brent) 54.0% 3.3 high Gold 8.3% -0.8 low Copper 19.6% 0.0 medium US 27.3% 3.0 high Europe 14.0% 0.7 high Japan 16.0% 1.2 high HFRX Global HF 4.4% 0.7 high Avg PE Fund 10.6% 1.3 high ZCF 1% left (vs for normal curve) Average market correlation with euro equities high 23.9% -0.2 medium 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 Global markets continued their sharp decline with most markets down double digits (i.e. S&P500-11%, Nasdaq - 11%, Nikkei %, SX5E -7%). The US 10-year yield dropped from 2.92% to 2.67% with the German 10-year yield dropping from 0.32% to 0.15%. Italy and EU reach a budget breakthrough after agreeing to reduce the deficit target from 2.4% to 2.04%. Since then the Italy-Germany 10-year bond spread decreased and is about 70 basis points off its recent high of 3.26%. The U.S. Federal Reserve hiked rates despite warnings from President Trump. Fed Funds target range is now 2.25% - 2.5%. Meanwhile, the Bank of England holds rates again at 0.75%, with QE unchanged. US job growth surges by 312k in December vs 176k expected. Unemployment rose to 3.9% as more workers joined the labour force. Wages increase picked up steam with a total average increase of 3.2% in OPEC and Russia decided to reduce oil production by 1.2m barrels a day. Softbank s mobile unit had his IPO on the Tokyo Stock Exchange, the second largest IPO of all time after Alibaba, raising $23.6 billion. Deutsche Bank Inquiry into suspected moneylaundering. The German bank s offices were rated by 170 police officers and tax officials. Unilever agreed to buy GlaxoSmithKline's (GSK) consumer-health division in India for $3.3 billion. Meanwhile, GSK made a deal to take over Tesaro, an American biotech company, for $5.1 billion 2018 GDP estimates were revised downwards for several EU countries. GDP ESTIMATES FOR 2018, DEVELOPED COUNTRIES US Consumer confidence is at a five-year low Inflation in the Eurozone is expected to be slightly down at 1.6% in December. The U.S. government has partially shut down over funding for President s Trump long promised wall at the US-Mexico border. Theresa May survived a vote of no confidence. The UK Parliament is still expected to vote on the UK s Brexit deal in the week beginning 15 January. America and China began negotiations in the hope of reaching a trade deal before March 1st. Both sides are carefully optimistic. Apple first earnings warning since 2002, dropping almost 9% on the day GDP growth forecasts for developing countries were also slightly down. French president Emmanuel Macron bowed to the gilets jaunes movement and promised a 10 billion package in addition to canceling the planned increase in fuel tax. So far, the momentum of the movement appears to be waning, but it is still too early to say. GDP ESTIMATES FOR 2018, DEVELOPING COUNTRIES Binyamin Netanyahu, Israel s prime minister, called for earlier elections to be held on 09/04. Huawei CFO, Meng Wanzhou, was arrested in Canada at the request of the United States but has since been granted bail. Prosecutors are seeking extradition to America over allocations that she misled financiers in doing business with Iran in violation of sanctions. Ex Renault-Nissan boss Charles Ghosn was sacked over allegations of financial misconduct. 5

6 Kurtosis Correlation in the equity markets The left tail moved away significantly from theoretical normality indicating that tail risks are to the downside. The right tail is 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 just 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 (60 days) 24% AVERAGE CORRELATION Average correlation decreased slightly to 24% (medium), as North America Equity Market correlation came down significantly with the rest unchanged. Multi-asset portfolio volatility We also look at a hypothetical multi-asset portfolio consisting of equities, bonds, gold, oil and hedge funds. 18.6% AVERAGE VOLATILITIES Average asset volatility increased sharply to 18.6%, while the benefit of (multi-asset) diversification only slightly increasing to (6.4%). In combination portfolio volatility rose fractionally from 8.0% to 12.2%. 12.2% 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) -5.4% Europe After a docile November, December showed its teeth with all regions showing significant losses. The Nikkei was -10.5%, North America was -9.1%, Asia ex- Japan was -3.1%, while Europe was -5.4%. STOCK PRICE PERFORMANCE: SECTORS (LOG SCALES) -9.2% FINANCIALS Sector price moved in tandem, with little to no diversification benefits % IT -9.8 % ENERGY 7.0 % CONSUMER STAPLES IT was -8.1%, Financials were -9.2%, Consumer Staples was - 7.0%, while Energy was -9.8% on a further weakening of the oil price. 8

9 Equities Volatility EQUITY VOLATILITY: REGIONS 19 % EUROPE North America rose to 27.0% (high), Asia ex-japan slightly fell to 14.6% (high down to medium), Europe rose to 19% (high) and Japan (Nikkei) rose to 30.1% (high). Regional volatility moves were up sharply across the boards after having started their climb last month. EQUITY VOLATILITY: SECTORS Sector volatility moves were very significant and all upwards. Energy rose to 25.0% (high), while Consumer Staples rose to 13.4% (high), Financials rose to 19.0% (high) and IT rose to 31.7% (high). 9

10 Equity Implied Volatility Market-Implied Near Term Outlook Implied Volatility Implied volatility fell as stock markets rose. The VIX rose from 18.1 to 25.4, while European implied volatility (VSTOXX) rose from 18.5 to 23.9 on the month. IMPLIED VOLATILITY 25.4 VIX 23.9 VSTOXX Implied vs Realised Volatility (European equity) implied volatility rose, as did realised volatility. As the move in realised volatility was more pronounced than for implied volatility, the ratio of implied/realised fell slightly though, ending at 125%. This ratio is still slightly above a neutral level, suggesting that the market still expects there to be further volatility-inducing news over the next 30 days compared to the last 30 days, although to a much lesser extent than previous months. IMPLIED VS. REALISED VOLATILITY 125%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 +1.2%, US bonds rose +2.1%; and Japan rose +0.9%. 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 2.2 % vs. -1.2% $ vs. -1.2% vs. Prices Currency moves were mixed vs. the euro. The Yen rose +2.2%, the dollar fell -1.2%, and sterling fell by -1.2% amid continuing uncertainty over Brexit. FX RATES VS. Volatility FX volatility moves were all downwards from very low levels and ended at 7-9%. /$ fell to 5.8% (high down to low), /Yen fell to 6.74% (medium down to low) and / fell to 6.3% (high). 5.8% vs. $ 6.3% vs. 6.74% 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. Volatility of Implied Volatility Volatility of implied volatility dropped back. Volatility of VIX rose to 154% (medium) and Volatility of VSTOXX rose to 160% (low up to medium). VOLATILITY OF VOLATILITY 154% US 160% EUROPE Major (Regional Equity) price moves (Equity) price moves very large, erasing all gains from the previous month and marking multi year lows. December 2018 has proven to be highly volatile and is for many markets among the worst performing months in the last decades. Point in case: the S&P 500 had it worst December since the Great Depression. 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. 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 -8.4% OIL 5% GOLD Commodities Prices Commodities once again saw some big price moves. Oil fell -8.4% to another new year low on global growth concerns. Copper fell -5.3% and Gold rose +5% in a flight to safety out of equities. Iron Ore rose 9.1% on the month, despite the increased concerns over global economic growth. Considering the -13.3% drop in November Iron Ore is still down -5% since October. COMMODITIES PRICES, $ -5.3% COPPER Volatility Volatility moves were mixed. Oil (Brent) further rose to 54% (high), Gold fell to 8.3% (medium down to low), and Copper fell to 19.6% (high down to medium). 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 -5.0 % EUROPE -8.9% US Real estate equities price moves were all dopwn on the month. -4.5% JAPAN The US fell by -8.9%, Europe fell -5.0%, and Japan was -4.5%. REAL ESTATE (REIT) VOLATILITY Volatility moves were either up or unchanged compared to previous month. Moves in US and Japan were very significant, breaking away from their average range the past year. The US rose to 27.3% (medium up to high), Europe was almost unchanged to 14.0% (high), and Japan rose to 16.0% (low to 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 fell -2.2%, while the average hedge fund was down -0.9% on the month. AI VOLATILITY 4.4% HFRX volatility 10.6% AVERAGE PE FUND Volatility of the average hedge fund rose to 4.4% (medium up to high) and an average PE fund was almost unchanged at to 10.6% (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 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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