MARKET RISK REPORT. Fairer Weather

Transcription

1 MARKET RISK REPORT Fairer Weather May 2016

2 Executive summary Volatilities dropped for most assets during April outside Japan. Volatilities ended low to medium relative to their 12-month averages. Realised volatility (of Eurostoxx equities over 30 days) rose slightly from 18.4% to 22. (still low). Equity market price moves were slightly positive, although Japan fell; volatility trends were mixed. Sector volatilities ranged from 9-16%, although Energy fell to 21%. Sector volatilities were low or medium relative to the last 12 months. Sovereign bond price moves were small during the month. Bond volatility changes were mostly down, ending at 4% (and 2.4% in Japan). Germany and the US were low, Japan was high. FX moves were small, although the Yen strengthened. Volatility trends were downwards: e.g. /$ down to 6.2% and / to 8.5%. Volatilities were low (Yen high though) compared to the last 12 months. Option volatility will have likely fallen as volatility of volatility was largely unchanged, and moves in underlying prices were small during the month. Volatility of volatility for the US rose to 102% (low). Commodities prices rose for a third consecutive month. Volatility moves were small e.g. Oil up to 43% (High). Real Estate (equity) price moves were slightly downwards. Volatility changes were downwards: to 13% in the US (low) and to 13% in Europe (low), but Japan rose to 24% (medium). PE Funds and Hedge Funds prices rose again, with volatility trends again downwards. 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 Volatilities once again dropped for almost all assets (outside Japan) during the month, with most ending at low or medium relative to the last 12 months. The commodity rally continued, but this month equities didn t follow. With oil futures rallying to near $50 the pressure has eased on the big oil producing countries, at least a little. Our perfect storm thesis (stretched asset valuations, tightening labour markets and dropping corporate profitability) of last month clearly hasn t played out yet, but these things take time. The notional size of the Fed put seems bigger than ever, as the probability of a June rate rise drops towards zero. It s curiously as if the central banks are scared of the markets, rather than vice versa. A potential catalyst for more volatility is the increasing bad debts in the Chinese system. But given that the government largely owns both lenders and borrowers this could again take some time to play out. Or could the Greek crisis once again spoil the start of the summer? The government debt load still seems unsustainable, but it s more a political than an economic issue. But for now markets are relatively quiet. ASSET CLASS EQUITIES VOLATILITY OF VOLATILITY GOVERNMENT BONDS FX VS $ COMMODITIES PROPERTY ALTERNATIVES KURTOSIS CORRELATION AREA LATEST VOLATILITY LATEST Z-SCORE REGIME North America 9.8% -1.0 low Asia ex-japan 10.6% -1.0 low Europe 15.5% -0,8 low Japan (Nikkei) 32.2% 0.8 HIGH Energy 20.7% -0.4 low Consumer Staples 9.3% -0.9 low Financials 15.6% -0.0 medium IT 11.6% -0.9 low Volatility of VIX 102% -0.7 low Volatility of VSTOXX 88% -0.6 low Germany 4.2% -1.3 low US 3.7% -1.6 low Japan 2.4% 1.0 HIGH Italy 5.3% -0.3 medium /$ 6.2% -1.9 low /Yen 13.8% 3.0 HIGH /CHF 3.2% -1.7 low / 8.5% -1.1 low Oil (Brent) 42.5% -0.1 medium Gold 15.7% 0.1 medium Copper 21.1% -0.2 medium US 12.6% -0.9 low Europe 13.2% -1.4 low Japan 24.2% 0.2 medium HFRX Global HF low Avg PE Fund 4.7% -1.1 low ZCF 1% left (vs for normal curve) Average market correlation with euro equities HIGH 16% -0.3 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 The level of newsflow remained high during the month. Donald Trump and Hilary Clinton all but ensured their respective party nominations. After failing to agree a government, Spain will go to the elections again in late June Italy set up a 6bn bad bank. BPV s capital raise attracted little interest and had to be underwritten by the bad bank. The Bank of Japan surprised markets in not increasing stimulus. The Yen rose sharply Australia cut interest rates from 2% to 1.75%. India cut its interest rate from 6.75% to 6.5% Apple shares dropped as iphone sales fell for the first time in Q1. Twitter shares also fell on a lower than expected revenue outlook US banks reported Q1 earnings down 25-6 on last year. European banks also reported earnings substantially down Peabody Energy filed for bankruptcy. Exxon Mobil lost its AAA rating with S&P. 59 US oil and gas companies have now filed for bankruptcy Austin Reed and BHS both went into administration. A Malaysian state fund, 1MDB, missed a payment of $1bn Puerto Rico s $72bn debt crisis worsened. Saudi Arabia raised $10bn to cover its budget deficit Abbott Labs agreed a $25bn acquisition of St Jude Medical. IMS Health and Quintiles announced a $9bn merger. Comcast bid $4b for DreamWorks. Alaska Airlines agreed to buy Virgin America for $4bn Pfizer called off its $160 billion merger with Allergan as US authorities continued to clamp down on tax inversions. Halliburton and Baker Hughes called off their merger after antitrust concerns were raised. Argentina issued its first international bond since its 2001 default Talks on freezing oil output collapsed, but a strike in Kuwait led to oil rallying. The IMF lowered global growth forecasts from 3.4% to 3.2% China s Q1 GDP grew by 6.7% % % 1. GDP ESTIMATES FOR 2016, DEVELOPED COUNTRIES 0.5% Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 US UK Spain Germany Euro Area Japan France Italy 2016 GDP estimates for developed countries were unchanged for almost all countries. The US and Japan were revised down -0.3pp each again. GDP ESTIMATES FOR 2016, DEVELOPING COUNTRIES 9% 8% 7% 6% 5% 4% 3% 2% 1% -1% -2% -3% -4% Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 China India Turkey Russia Brazil 2016 GDP growth forecasts for developing countries were also largely unchanged, the exception being Brazil, which was again revised down, to -3.7%. 5

6 Kurtosis in the equity markets While the left side of the eurozone equity market distribution remained very close to a normal shape during the month the right tail opened out to 2.91 vs a theoretical normal Backtest failures are likely to have been below a normal level over the last month due to low volatilities, and relatively low correlations (see below) CORNISH-FISCHER EXPANSION OF EURO STOXX 50 While the left side of the eurozone equity market distribution remained very close to a normal shape during the month the right tail opened out to 2.91 vs a theoretical normal 2.33 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 and

7 Inter-market correlations with EU equities INTER-MARKET CORRELATIONS 4% AVERAGE CORRELATION North America Japan Bunds (negative) /$ Average Correlations fell slightly again during the month, with correlations falling for most assets, offset by a slight rise in Japanese equities. Average correlation fell from 2 to 16%: still medium 3 25% 2 15% 1 5% -5% -1-15% MULTI-ASSET PORTFOLIO Average asset Multi-asset portfolio Diversification impact 1% AVERAGE VOLATILITIES We also look at a hypothetical multi-asset portfolio consisting of equities, bonds, gold, oil and hedge funds. Average asset volatilities rose slightly from 15% to 16% during the month, while the benefit of diversification remained flat at -7%. In combination portfolio volatility rose from 8. to 8.8%. 0.8% 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) , EUROPE ,000 North America Europe Asia ex-japan Japan (rh axis) Market movements were mixed during the month. North America ended the month at +0.7% and Europe +1.. Asia ex-japan was -1. and the Nikkei -0.6% STOCK PRICE PERFORMANCE: SECTORS (LOG SCALES) Energy Consumer Staples IT Financials, rh axis Sector moves were also mixed. Energy rose again by +8.5%, and Financials +3.2%. Consumer Staples were -0.7% and IT -4.3% % FINANCIALS 4.3% IT 8.5% ENERGY 0.7% CONSUMER STAPLES 8

9 Equities Volatility 45% EQUITY VOLATILITY: REGIONS 4 35% 3 25% 2 15% 1 5% 32.2% NIKKEI North America Europe Asia ex-japan Japan (Nikkei) Regional volatility changes were also mixed, ending at 10-15% (Japan was 32.2%). All regions stayed at low volatility, with the exception of Japan which rose back to high. 5 45% 4 35% 3 25% 2 15% 1 5% EQUITY VOLATILITY: SECTORS 21% ENERGY SECTOR Energy Consumer Staples IT Financials Sector volatility moves were generally downwards. They ended at 9-16%, while the Energy sector fell back to 21%. Sectoral volatility were lower: Consumer Staples and IT stayed low while Energy fell from medium to low and Financials fell from high to medium. 9

10 Equity Implied Volatility Market-Implied Near Term Outlook Implied Volatility Implied volatilities rose in both the US and Europe. The VIX rose to 15.7 while European implied volatility (VSTOXX) rose to IMPLIED VOLATILITY VIX VSTOXX VSTOXX VIX Implied vs. Realised Volatility (European equity) implied volatility rose slightly, but realised volatility rose slightly more, and so the ratio of implied/realised fell from 127% to 109%. This remains fractionally above a neutral level, suggesting that the market saw it as slightly more likely than not that there would be volatility-inducing news over the next 30 days. IMPLIED VS. REALISED VOLATILITY 45% 4 35% 3 25% 2 15% 1 5% Greece (May, Jun) Taper tantrum 2 (Aug) Fed holds, more ECB QE (Nov) Fed raises, ECB disappoints (Dec) BoJ goes negative Oil price trough (Jan) % IMPLIED/REALISED VOLATILITY 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 changes were small and mixed during the month. German bonds fell -0.9%, while the US fell -0.3% and Japan +0.1% Germany US Japan Italy SPANISH 10Y BOND YIELD % SPANISH BOND YIELDS 1.6% 1.4% Spain Yield VOLATILITY OF 10Y BOND FUTURES 9% 8% 7% 6% 5% 4% 3% 2% 1% Volatility Volatility moves were mostly downwards. German bond volatility fell to 4.2% (medium down to low) and US bonds fell to just 3.7% (medium down to low). Japan was unchanged at 2.4% (high volatility compared to the last 12 months.) Germany US Japan Italy 11

12 Foreign Exchange Prices FX moves were very large with the euro strengthening sharply: +4.7% vs the Dollar and 4.6% vs the Yen. Sterling weakened -1.4% with continuing concerns over Brexit. Most EM FX currencies strengthened vs the Dollar, with moves of 7-11%. FX RATES VS. 1.4% vs. 4.6% vs /$ /JPY /100 / (rh axis) 0.90 Volatility FX volatility trends were downwards. /$ fell to 6.2% (low), / fell to 8.5% (medium down to low). /Yen rose though, to 13.8% (medium up to high relative to 12 month averages.) VOLATILITY OF FX RATES VS. 6.2% vs. $ 8.5% vs. 13.8% vs. 16% 14% 12% 1 8% 6% 4% 2% / /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 slightly in the US ending at 102% (low) and fell slightly in Europe to 88% (also low relative to the last 12 months.) Volatility of volatility is unlikely to have been a big driver of option volatility during the month. 30 VOLATILITY OF VOLATILITY % US % EUROPE Volatility of VIX Volatility of VSTOXX Major (Regional Equity) price moves (Equity) price moves were relatively small during the month, as were most bond and FX moves. Underlying price moves are also unlikely to have been a big driver of option volatility. 2 CHANGE IN PRICES OF EQUITY INDICES, 30 DAYS 15% 1 5% -5% -1-15% -2 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 Commodities 23.7% IRON Prices Commodity prices rose for the third month in a row. Oil rose +21.5%, Gold +4.6% and Copper +4.4%. Iron Ore rose +23.7%. 21.5% OIL COMMODITIES PRICES 1,300 1, % GOLD ,100 1, % COPPER Oil (Brent) Copper (indexed) Iron Ore Gold (rh axis) Volatility Volatilities were largely unchanged: Oil finished at 43% (medium) and Gold at 16% (high down to medium). Iron Ore fell to 45% as the oneday +26% move sparked by Chinese pro-growth commentary dropped from the time period COMMODITIES VOLATILITY 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 (Real Estate Share Prices) REAL ESTATE (REIT) PRICES 2,400 3,600 2,300 2,200 3,400 3, % EUROPE 2,100 3,000 2,000 1,900 2,800 2, % US 1,800 2,400 Europe Japan (rh axis) US (rh axis) Real estate equities had a weaker month. Europe fell -0.5%, the US -2.8% while Japan recorded a slight gain of +0.6%. 0.6% JAPAN 6 REAL ESTATE (REIT) VOLATILITY Europe Japan US Volatility moves were generally downwards on the month. The US fell to 13% (medium down to low), Europe fell to 13% (low), but Japan rose to 24% (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 1,200 1,180 1,160 1,140 1,120 1,100 1,080 1,060 1,040 1,020 1,000 HFRX Global HF (EUR) Avg PE Fund (indexed) PE funds and hedge funds finally had another positive month, with PE funds up +0.4% and hedge funds +0.3%. 18% AI VOLATILITY 3. HFRX volatility 14% 12% 1 8% 16% 4.7% AVERAGE PE FUND 6% 4% 2% HFRX Global HF Avg PE Fund Volatilities were again down on the month: the global hedge fund index (HFRX) fell slightly to 3. (low) while the volatility of an average of PE fund fell to 4.7% (low by the standards of the last 12 months). 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 30th April 2016, and the commentary was written on or before 11th May 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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