Dr Adrian Banner, CEO & CIO of Intech, notes that there is likely to be an increased risk that the market will continue to suffer drawdowns as equity market volatility increases in the future.
Despite a short-term spike in February, volatility has been unusually subdued. Why has that been the case?
Volatility was at unusually low levels from August 2016 through to January 2018, coinciding with very strong market returns. Global economies are growing and monetary policies have furnished additional support, while investors shrugged off the negative tail risk of geopolitical instability. In Intech’s Equity Market Stress MonitorTM, we observe that dispersion of returns of stocks across equity markets remains near historically low levels, which is indicative of excessive group think and consistent with the low volatility environment. This has tended to increase the risk that the market will suffer drawdowns as volatility increases in the future.
Market-based risk metrics have been at extremes. Which, if any, signals a reversion to the mean? What does that mean for investors?
When market-based risk metrics move far from their norms, there has tended to be an increased risk that investors will overreact to bad news, leading to market drawdowns. Sometimes, as in the aftermath of the Brexit vote in 2016, the drawdown was quickly corrected. In other cases, such as the Global Financial Crisis, the recovery took years. Intech’s equity market stress metrics – applied to various indices – continue to exhibit extreme levels when compared to historical values. The greater the deviation versus the long-term mean, and the longer it persists, the more likely it is that the return to the norm will be abrupt and accompanied by substantial volatility. Given that extreme readings persist across indices, investors should continue to prepare for a less likely, but more significant, move downward in global equity markets.
Which segments of the global equity market currently appear to have the most attractive risk-adjusted return opportunities?
The Intech Equity Market Stress MonitorTM currently exhibits extreme levels in three out of five metrics for all broad markets. In addition, European equities are showing even greater strain. As such, investors in equities, regardless of market segment, should consider preparing for a potential drawdown as volatility increases. Even so, equity markets still offer a high level of reward and liquidity, so risk-managed strategies in any segment of the global equity market may offer the most attractive risk-adjusted return opportunities.
Intech is a Janus Henderson subsidiary and subadvisor that uses a mathematical investment process to harness stock price volatility as a source of excess return and a key to risk control.
The Intech Equity Market Stress Monitor is a trademark registered under INTECH Investment Management LIMITED LIABILITY COMPANY.