If “The Market Climbs a Wall of Worry” What Happens When the Market Stops Worrying?

In our Quarterly Insight Risk Review for the fourth quarter and full year 2017 we reviewed the risk landscape over the past year (risk fell sharply in the first half, and was down again, albeit with a smaller decline, in the second half). It is hard to believe that US short-horizon equity risk hit a low of just north of 5% in November. Global risk was higher, but not by much. We believe one of the main precipitating forces of this low level of volatility is the also-near-record low level of correlations, particularly asset correlations, across a wide variety of geographies.

We also noted that some components of risk – notably market and country risk of developed and emerging markets – started to tick back up in December, creating diverging views, particularly with currency risk. Perhaps the era of shockingly low volatility is coming to an end – an end likely precipitated by a sharp decline in equity values.

We use a risk lens to try to divine the performance of stocks going forward – of course it does not cover the gamut of inputs and outcomes, but these signals have been reliable in the past. And our conclusion is decidedly mixed. But we identified a number of factors, positive, neutral and negative, that could precipitate or forestall a decline in stock prices and lead us out of the bizarro world of extremely low volatility. Obviously, this is not a comprehensive list, but just a bit of food for thought.



To learn more about the low level of volatility means, see my colleague Oliver d’Assier’s blog post, "The downside of too little downside risk".

For access to the full Q4 Insight Report, click here.

Melissa Brown, CFA

As Managing Director of Applied Research, Melissa Brown generates unique insights into risk trends by consolidating and analyzing the vast amount of data on market and portfolio risk maintained by Axioma. Brown’s perspectives help both clients and prospects to better understand and adapt to the constantly changing risk environment.