"Before I speak I have something important to say" Groucho Marx

The flux in equity markets remains as the uncertainty over the US trade deal with China continues to be the focus of investor sentiment. The US equity market has given back around 4%, in the past week or so. Maybe two-thirds of what we could see in a further correction but remains well in the blue from the start of the year. On a slightly more positive note, the recent underlying economic data is somewhat more encouraging as the percentage of countries with improving leading indicators is rising. Earnings season for the first quarter was a very modestly positive year on year. In contrast to a forecast of a decline, although the number of companies that were cautious for the year rose. According to a report in the Financial Times.

 Comparing some asset classes to get an understanding of risk appetite can be useful at these times. The Russell 2000 has started to modestly outperform the broader index over the past couple of days, considered a positive. The US dollar continues to underperform the Japanese yen, a sign of risk aversion. The Bitcoin price has started to be considered bell weather for risk appetite; it has been rising. Consumer discretionary has outperformed staples from the start to the year; that trend has reversed recently. The spread between high yield and US Treasuries, that rose sharply in December during the broad selloff, has not, so far at least, reacted in a material way. The VIX index closed above 21 indicating risk aversion is rising, in the past to a level that has seen some stabilisation and recovery. Gold, another asset that tends to increase during periods of risk aversion, has not so far reacted to the recent rise in volatility.

According to several reports, if traders positioning is an indication, the low volatility we enjoyed at the start of the year was expected to remain into the rest of the year. The Federal Reserve’s dovish stance at the beginning of the year feeding the view. Hedge funds and speculators have been selling options, taking in the premium to gain yield on the portfolio, to a greater degree than many other points in history. Another sign investors have become complacent. During times of stress, this investment strategy can be a painful one to manage. Hedging strategies may help fund managers sleep at night; they often don’t make any money for the clients.

The recent tension between the US and China on a trade agreement has seen to be the catalyst causing the recent volatility. The one that could have more impact will be the Fed’s interest rate policy for the year ahead. Inflation data has been declining; this has stimulated the Fed’s change in stance. Should this remain to be the case, and trade worries continue this could help the Fed keep its dovish stance. However, this may not help in the short term as equities still need to consolidate a strong rise from the start of the year.

 

Posted on May 10, 2019 .