Executive summary Volatility moves were almost all downwards in February. They were low relative to their 12-month averages almost everywhere. Realised volatility (of the Eurostoxx index over 30 days) rose just fractionally from 10. to 10.6% (low). Equity market price moves were upwards during the month. Volatility trends were all downwards. Sector volatilities ended at 6-9% (but with Energy at 13%). Sector volatilities were all low relative to the last 12 months. Sovereign bond price moves were also positive. Bond volatility moves were downwards, ending at 4% (but down to 1.2% in Japan). All three major regions had low volatility. FX price moves were bigger than of late with the euro weaker. Volatility trends were downwards: e.g. / down to 5.8%. Volatilities were low for all major currencies relative to the euro. Option volatility will likely have been mixed, driven not by volatility of volatility, which was flat, but with some large moves in underlying prices during the month. Volatility of volatility for the US ended at 76% (low). Commodities price moves were small, with Oil falling but Gold up. Volatility moves were downwards e.g. Oil down to 18% (low). Real Estate (equity) price moves were generally upwards. Volatility moves were small and finished at 10-11% (all low). PE Funds prices were fractionally down, with volatility trends in PE and hedge funds down. Niall O Connor
Table of contents 1. Summary volatility matrix p. 4 2. Key News p. 5 3. Kurtosis & correlation in the equity markets p. 6-7 4. Equities p. 8-9 5. Equity Implied Volatility p. 10 6. Fixed Income p. 11 7. Foreign Exchange p. 12 8. (Equity) Options p. 13 9. Commodities p. 14 10. Real Estate (Real Estate Share Prices) & Alternatives p. 15-16
Summary volatility matrix Volatility changes were downwards again almost everywhere. It s a full 10 years on from 2007 when equity market volatility had all but disappeared. And the parallels don t stop there: equity markets and debt to GDP have reached new highs, there is a hunt for yield and investment managers are missing volatility target ranges to the downside and have started asking us how to increase their volatility. And yet in the face of this the list of tail risks remains long: US rate rises, French and German national elections, a possible post-brexit breakup of the UK and/or EU, the ECB starting to taper, rising inflation in the UK and US, and further fallout from the lower oil price in oil producing countries as deficits remain high. It seems very unlikely that volatility will remain so low for long. ASSET CLASS EQUITIES VOLATILITY OF VOLATILITY GOVERNMENT BONDS FX VS $ COMMODITIES PROPERTY ALTERNATIVES KURTOSIS CORRELATION AREA LATEST VOLATILITY LATEST Z-SCORE REGIME North America 5.4% -1.2 low Asia ex-japan 5.9% -1.8 low Europe 7.3% -1.0 low Japan (Nikkei) 14. -0.9 low Energy 13.2% -1.0 low Consumer Staples 7.6% -0.8 low Financials 9. -0.8 low IT 5.6% -1.4 low Volatility of VIX 76% -0.7 low Volatility of VSTOXX 7-1.2 low Germany 4. -0.6 low US 3.9% -0.5 low Japan 1.2% -1.4 low Italy 7.5% 1.8 HIGH /$ 5.8% -1.0 low /Yen 7.9% -0.6 low /CHF 3.5% -0.5 low / 7.9% -0.6 low Oil (Brent) 17.6% -1.8 low Gold 9.3% -1.5 low Copper 26.5% 1.7 HIGH US 10.9% -1.2 low Europe 10.2% -0.8 low Japan 11.1% -0.8 low HFRX Global HF 2.8% -0.2 medium Avg PE Fund 3.7% -1.2 low ZCF 1% left (vs -2.33 for normal curve) Average market correlation with euro equities -2.21 0.4 medium 33% 0.7 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
Key News Major Volatility-Driving Events Newsflow picked up after a lull in the first two months of the year. Stockmarkets in the US hit new record highs The US imposed new sanctions on Iran after it conducted a missile test. North Korea also tested a missile, and the dictator s half-brother was assassinated in Malaysia The Trump administration asked the Treasury to re-examine the onerous requirements of the Dodd-Frank act. The US trade deficit reached a new post-2012 high boosted by a strong Dollar US inflation rose to 2.5% in January on higher oil prices. UK inflation rose to 1.8%, with the weaker pound not yet fully captured The spread between French and German bond yields continued to widen on increasing fears of a eurozone breakup The ECB denied that it was considering tapering its bond purchase programme General Motors and the major mining companies posted good earnings figures. Toshiba announced a $6bn write-down. AIG announced a $3bn quarterly loss. Hanjin Shipping announced bankruptcy. Lloyds made its best annual profit since 2006 PSA Group agreed to buy GM s European operations. Kraft Heinz announced a $143bn takeover of Unilever, but shortly afterwards withdrew it. Verizon reduced the amount of its bid for Yahoo after it was discovered that Yahoo had been the subject of two successful hacking attempts. The merger between Anthem and Cigna was also blocked after last month s judgement against the merger of Aetna and Humana on anti-trust concerns. The merger between the LSE and Deutsche Börse was close to collapse Japanese GDP grew by 1. in 2016. India s economy grew by a claimed 7% in Q4 2016. Nigeria s economy continued to deteriorate with oil prices lower, and it had its first negative annual GDP in 25 years 2.5% 2. 1.5% 1. GDP ESTIMATES FOR 2016, DEVELOPED COUNTRIES 0.5% Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 9% 8% 7% 6% 5% 4% 3% 2% 1% US UK Spain Germany Euro Area Japan France Italy 2017 GDP estimates for developed countries were once again revised up for most countries. The exception was the US which was nudged downwards GDP ESTIMATES FOR 2016, DEVELOPING COUNTRIES Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 China India Turkey Russia Brazil 2017 GDP growth forecasts for developing countries were revised down again for Brazil and Turkey. 5
Kurtosis in the equity markets The left tail of the eurozone equity market distribution drifted back towards its theoretical normal -2.33 and finished at -2.21. The right tail also stayed close to its theoretical normal level. 4 3 2 1 0-1 -2-3 -4 CORNISH-FISCHER EXPANSION OF EURO STOXX 50 The left tail of the eurozone equity market distribution drifted back towards its theoretical normal - 2.33 and finished at -2.21. 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: +/- 2.33. 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 2010. 6
Inter-market correlations with EU equities INTER-MARKET CORRELATIONS 10 4% AVERAGE CORRELATION 8 6 4 2-2 -4-6 -8 North America Japan Bunds (negative) /$ Average Average correlation rose again from 29% to 33% (high). Average correlations remained high during the month, led by North American equities and Bunds. 3 25% 2 15% 1 5% -5% -1-15% MULTI-ASSET PORTFOLIO Average asset Multi-asset portfolio Diversification impact 2.4% AVERAGE VOLATILITIES 1. PORTFOLIO VOLATILITY We also look at a hypothetical multi-asset portfolio consisting of equities, bonds, gold, oil and hedge funds. Average asset volatilities fell again from 10.4% to 8. during the month, while the benefit of (multi-asset) diversification reduced from -5.7% to -4.3% as correlations increased. In combination portfolio volatility dropped from 4.7% to 3.7%; and reached a new 12-month low. 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
Equities Stock price STOCK PRICE PERFORMANCE: REGIONS (LOG SCALES) 2000 20,000 2.5 % Europe 1000 10,000 North America Europe Asia ex-japan Japan (rh axis) Equity indices rallied strongly during the month. North America rose +3.4% including making new record highs, Asia ex-japan rose +2.3% and Europe +2.5%. The Nikkei rose, but by just +0.4%. STOCK PRICE PERFORMANCE: SECTORS (LOG SCALES) 240 220 200 160 150 140 130 2.2% FINANCIALS 180 160 140 120 Energy Consumer Staples IT Financials, rh axis Sector price moves were mostly strongly positive. IT rose +4.5% for the second month in a row, Financials +2.2% and Consumer Staples +4.2%, while Energy fell back -2.6% on a lower oil price. 120 110 100 90 80 4.5% IT 2.6% ENERGY 4.2% CONSUMER STAPLES 8
Equities Volatility EQUITY VOLATILITY: REGIONS 45% 4 35% 3 25% 2 15% 1 5% 14. NIKKEI North America Europe Asia ex-japan Japan (Nikkei) Regional volatilities all fell again on the month. North America ended at 5.4% (low), Asia ex-japan at 5.9% (low), Europe at 7.3% (low), and Japan to 14. (low). EQUITY VOLATILITY: SECTORS 4 35% 3 25% 2 15% 1 5% Energy Consumer Staples IT Financials between 6-9% All sector volatilities Sector volatility moves were more mixed. They ended at 6-9%, with Energy the outlier again at 13.2%. All sectors ended with low volatility. 9
Equity Implied Volatility Market-Implied Near Term Outlook Implied Volatility Implied volatilities were relatively unchanged on the month. The VIX rose from 12.0 to 12.9 while European implied volatility (VSTOXX) fell from 17.4 to 16.3. 45 IMPLIED VOLATILITY 35 30 12.9 VIX 40 25 10 5 0 16.3 VSTOXX 20 15 VSTOXX VIX Implied vs. Realised Volatility (European equity) implied volatility was again down on the month while realised volatility was close to flat. So the ratio of implied/realised fell back from 173% to 154%. This ratio is still well above a neutral level, suggesting that the market expected there would continue to be volatilityinducing news over the next 30 days compared to the last 30 days; the Dutch election might be a case in point here. IMPLIED VS. REALISED VOLATILITY 45% 4 35% 3 Fed hints at June rate rise (May) Fed hints at rate rise (Sep) Italian referendum (Dec) 30 25 20 19% IMPLIED/REALISED VOLATILITY 25% 2 15 15% 10 1 5% Brexit (Jun) Trump victory (Nov) 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
Fixed Income 10-Year Government Bond Futures PRICES OF 10Y BOND FUTURES 170 165 160 155 150 145 140 Prices Government bond price moves were all positive on the month. German bonds rose +2.4%, and Japanese were +0.5%, with US bonds also +0.5%. 135 130 125 120 Germany US Japan Italy SPANISH 10Y BOND YIELD 2.0 1.8 1.6 1.4 Spanish bond yields rose to 1.6% as fears of a eurozone breakup increased. 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Spain Yield VOLATILITY OF 10Y BOND FUTURES 9% 8% 7% 6% 5% 4% Volatility Volatilities were down on the month. German bond volatility fell to 4. (high down to low), the US to 3.9% (medium down to low) and Japanese bonds fell slightly to 1.2% (low compared to the last 12 months). 3% 2% 1% Germany US Japan Italy 11
Foreign Exchange 0.4% vs. 2.6% vs. 1.6% vs. $ Prices FX moves were more pronounced last month, with the Dollar +1.6%, the Yen +2.6% vs the euro. Sterling rose, but by just +0.4%. 1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35 1.40 1.45 1.50 FX RATES VS. /$ /JPY /100 / (rh axis) 0.65 0.70 0.75 0.80 0.85 0.90 Volatility FX volatility moves were all downwards. /$ fell to 5.8% (medium down to low), / to 7.9% (medium down to low), and /Yen to 7.9% (medium down to low relative to 12 month averages.) VOLATILITY OF FX RATES VS. 5.8% vs. $ 7.9% vs. 7.9% vs. 3 25% 2 15% 1 5% / /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
(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 was relatively unchanged on the month, with the US ending at 76% (low) and Europe at 7 (medium back down to low relative to the last 12 months.) Volatility of volatility is unlikely to have been a driver of option volatility during the month. 25 VOLATILITY OF VOLATILITY 20 76% US 15 10 5 7 EUROPE Volatility of VIX Volatility of VSTOXX Major (Regional Equity) price moves (Equity) prices saw relatively big moves during the month (and correlations between major indices have been unusually low over the last few months.) Underlying price moves are likely to have been a driver of option volatility. CHANGE IN PRICES OF EQUITY INDICES, 30 DAYS 2 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.
Commodities 0.2% OIL 3.7% GOLD Prices Commodity price moves were small during the month. Oil fell, by -0.2% on the month. Gold rose +3.7% (despite rising risk asset prices) while Copper reversed last month s gain with a slight loss of -0.9% after making a new 12-month high on higher global economic growth prospects. Iron Ore also made a new 12-month high. COMMODITIES PRICES 0.9% COPPER 100 90 80 70 60 50 40 30 1,400 1,300 1,200 1,100 1,000 900 800 700 600 Oil (Brent) Copper (indexed) Iron Ore Gold (rh axis) Volatility Volatility changes were down for most assets; Oil finished down again at 18% (low) while Gold fell slightly to 9% (low) but Copper rose again to 27% (high on a very narrow range). COMMODITIES VOLATILITY 8 7 6 5 4 3 2 1 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
Real Estate (Real Estate Share Prices) REAL ESTATE (REIT) PRICES 2,400 2,300 3,600 3,400 4.5 %EUROPE 2,200 3,200 2,100 3,000 2,000 1,900 2,800 2,600 3.3% US 1,800 2,400 Real estate equities price moves once again reversed the prior month s moves and were generally up on the month along with most risk assets. Europe was up +4.5%, the US +3.3% while Japan was down -0.9%. 0.9% JAPAN Europe Japan (rh axis) US (rh axis) REAL ESTATE (REIT) VOLATILITY 6 5 4 3 2 1 Europe Japan US Volatility moves were small. The US fell to 10.9% (low), Japan dropped to 11.1% (low) and Europe was flat at 10.2% (low). 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
Alternatives ALTERNATIVES PRICES 1,250 1,200 1,150 1,100 1,050 1,000 950 900 850 Global Hedge Funds (EUR) Avg PE Fund (indexed) PE funds finally had a negative month at -0.1%, while the average hedge fund rose again, this time by +1.. AI VOLATILITY 2.8% HFRX volatility 12% 1 8% 14% 6% 3.7% AVERAGE PE FUND 4% 2% Global Hedge Funds (EUR) Avg PE Fund Global hedge fund volatility fell slightly to 2.8% (medium) while the volatility of an average of PE fund fell to just 3.7% (medium back down to low by the standards of the last 12 months). 16
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 28th February 2017, and the commentary was written on or before 12th March 2017. 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 - 2016 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.