In this video, Dr Ashwin Alankar, Global Head of Asset Allocation and Risk Management at Janus Henderson, discusses the reasons – including fiscal stimulus and dollar weakness – why option market signals are showing a strong preference for US large-cap equities.
- Market prices embody forward-looking information about future risks; the market is smart and hard to beat.
- Very rarely does the options market indicate that only one equity region is looking attractive/unattractive.
- Currently, there is a strong options-based signal about the attractiveness of US equities (specifically large caps) versus Europe, Asia, and emerging market equities.
- Options-based signals indicate the concerns that people are placing on tariffs and the US trade environment going forward look overblown.
One thing which is innovative, or unique, about how we go about assessing the attractiveness of different asset classes going forward is: we use market prices themselves to give us insight into whether or not a certain asset class is less attractive, more attractive, or of equal attractiveness to other asset classes. Why market prices? Well, market prices for two important reasons. One, they are forward looking. They embody forward-looking information about future risks. And two, we know the market is smart. We know it is intelligent. We know the market is very hard to beat. So why not use the information that an intelligent system is telling us? And the market prices that we focus on are option prices.
Option prices or option contracts are insurance contracts. They represent an insurance premium. And what we know is, if the price of insurance to protect against losses increases, that immediately tells us that the risks to the downside have increased. If the price to participate in the upside has increased, that directly and immediately tells us the probability of an asset enjoying a run-up has increased.
Very rarely does the options market indicate that only one equity region is looking attractive or only one equity region is looking unattractive. Today, we find that the only one equity region which is looking attractive is US large-cap equities. When it comes to European equities, Asian equities, and emerging market equities, the options market is painting a bleak picture.
So, why is that the case? We believe it has to do potentially with two fundamental reasons. The first is: only the US is really seeing talk about fiscal stimulus, whether that’s fiscal stimulus coming in the form of repatriation, whether in the form of tax reform – which has already happened – or whether in the form of actual spending by the US Treasury. Fiscal stimulus should help offset the withdrawal of monetary stimulus.
The second fundamental reason we believe the options market is pointing to unattractiveness in equity regions outside of the US has to do with US dollar weakness. A weaker dollar, a stronger euro, is going to impose a strong headwind on countries such as Germany, France, and Italy, as those economies rely on exports. Similarly, a stronger yen will hinder economic growth in Japan. Japan, just like Germany, is a country, an economy, which relies on exports. It’s a country which has a current account surplus, and saves. A stronger yen hurts their ability to export, and their ability to save.
On the trade side, one of the biggest risks many people worry about today is government policy and government regulation coming in, which is going to impair open and free trade – whether through tariffs, embargos, etc. The options market, on the other hand, doesn’t really ‘buy’ that argument. One specific reason and piece of evidence here concerns Canada and Mexico. The options market, in fact, is both seeing attractive gains to be earned relative to potential losses by allocating to Canadian equities, and by allocating to Mexican equities; thereby reflective of a NAFTA policy that is likely going to be fair, versus punitive, towards Canada and Mexico. So our options-based signals are telling us the risk that people or the concerns that people are placing on trade, tariffs, and the trade environment going forward looks a bit overblown.
NAFTA = the North American Free Trade Agreement, a treaty between Canada, Mexico, and the US. In January 2017 US President Donald Trump signed an executive order to renegotiate NAFTA.
These are the views of the manager at the time of recording in March 2018. They may differ from the views of others at Janus Henderson Investors. Sectors, indices and securities mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell any of them.
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