Weekly Digest: the blame game
02 Jul 2020
Two years ago equity markets were in freefall, but the circumstances were quite different to the present.
As has been universally acknowledged, the match that lit the flame of the current correction was the release of US employment data on February 2nd revealing a sharp increase in annual hourly earnings growth from 2.5% to 2.9%, suggesting a very tight labour market. There was a mitigating factor in the news that average weekly hours worked fell from 34.5 to 34.3. The change in the denominator alone boosted hourly wages by around 0.5%, but nobody seemed to care, suggesting that investors were primed to interpret any news as bad, much more attuned to the risks than the rewards. And not without reason, perhaps, given the duration of the bull market and the unprecedentedly long period of subdued volatility. Also, although very difficult to prove, there is a feeling that the market was not positioned for higher inflation, so suddenly a lot of people had to rejig portfolios. This has echoes of the 2013 “Taper Tantrum”, when investors suddenly woke up to the risk of tighter monetary policy following comments from Federal Reserve chairman Ben Bernanke.
Still, that doesn’t fully explain the extreme speed of the sell-off. Fire investigators first look for the origin of a fire, then turn their skills to seeking the accelerant. This can be something, such as a flammable liquid, that just happened to be there, or it could have been deliberately applied to make the fire worse. In this particular market conflagration, the finger of blame is being firmly pointed at funds that were exposed to “short volatility” positions. It would be hard to make criminal allegations in these cases, but there are certainly accusations of negligence and recklessness.
|FTSE 100 Weekly Winners|
|Direct Line Insurance Group||1.0%|
|Paddy Power Betfair||0.2%|
|FTSE 100 Weekly Losers|
|Standard Life Aberdeen||-9.1%|
Risk Parity and Variable Annuity funds are different beasts. They, very simplistically, raise their weightings in riskier assets such as equities as volatility falls (because falling volatility is taken as an indicator of a lower risk of loss). As volatility rose, they were forced by their own rules to sell equities. Naturally, both industries deny that they are to blame, but they are surely at least part of the problem, if not all of it. A white paper written by Christopher Cole of Artemis Capital Management (NOT the UK fund manager) in October 2017, calculated that there was as much as $1.5 trillion of funds exposed to “short volatility” strategies in some form or other, and that it was an accident waiting to happen. But even he could not predict the catalyst or timing.
The good news is that markets have rediscovered their poise, for now at least, but another test awaits us on Wednesday in the form of the US Consumer Price Index release for January. Economists in aggregate are forecasting a fall back to 1.9% from 2.1% in December, which should come as some relief if the forecast is met. US bond investors are not taking any chances, though, with the 10-Year yield still at a four-year high of 2.85%. We definitely appear to have left the deflation risk era behind us for now.
Finally, a slightly more optimistic thought. The performance of US High Yield corporate bonds has been resilient. Although spreads (391 basis points from a low of 334 bps) and yields (6.6% from 5.9%) have backed up a bit, there are no real signs of stress, underlining the fact that markets remain relatively relaxed about the growth outlook. This is important in light of last week’s observations that bear markets tend to be associated with recessions. Finally, the nickname of the Ugandan basketball national sports team is the Silverbacks. This week, the Olympic Basketball gold medal has been won by either the USA or the Soviet Union at 17 out of 19 summer games. Who were the other two winners?
Year-to-date market performance
FTSE 100 Index, past 12 months
Past performance is no indicator of future performance
This newsletter is for professional financial advisers only and is not intended to be a financial promotion for retail clients. The information in this document is for private circulation and is believed to be correct but cannot be guaranteed. Opinions, interpretations and conclusions represent our judgement as of this date and are subject to change. The Company and its related Companies, directors, employees and clients may have positions or engage in transactions in any of the securities mentioned. Past performance is not necessarily a guide to future performance. The value of shares, and the income derived from them, may fall as well as rise. The information contained in this publication does not constitute a personal recommendation and the investment or investment services referred to may not be suitable for all investors. Copyright Investec Wealth & Investment Limited. Reproduction prohibited without permission.
Member firm of the London Stock Exchange. Authorised and regulated by the Financial Conduct Authority.
Investec Wealth & Investment Limited is registered in England.
Registered No. 2122340. Registered Office: 2 Gresham Street, London EC2V 7QP.