Keep Calm and Consult your Magic Eight Ball

It is the time of year for glass ball predictions and, being someone (allegedly) hardly given to false modesty, I will add my own voice to the chorus, albeit from a risk management point of view. Now a wild, night-roaming gipsy like me is not expected to be taken seriously but that has never stopped me before.

The question being asked is whether we are witnessing irrational exuberance in the markets and if this prolonged rally, like many before it, will come to an abrupt end and take its place in the chapter of things that have ceased to be.

In favor of the ‘Nay’ side, all 45 members of the OECD have achieved GDP growth this year, and forecasts for next year are even stronger. The IMF says global growth was 3.2% in 2016, 3.6% in 2017, and is forecasted at 3.7% in 2018. The fastest growth rate since 2010. Even Fed Chair Yellen, quoted in the WSJ, said “The global economy is doing well. We’re in a synchronized expansion. This is the first time in many years we’ve seen this”, and raised her forecast for US economic growth next year to 2.5% (up from 2.1% in September). Earnings continue to come in at a higher-than expected clip as well. So, the fundamentals look strong.

From the risk side, volatility is at or near record lows. Dispersion, the mother’s milk of stock-pickers, is high and rising, 60-day average asset-to-asset correlation, nefarious as it may become, remains in check , and average daily volume has surged since the summer lows. So, the technical looks strong too.

On the side of those who worry, the FTSE All World index has climbed every single month this year – the first time in its 30-year history according to the WSJ. The last two rallies lasted 26 (Feb 2009 – Apr 2011), and 25 (May 2012 – June 2014) months respectively. The current one started in February 2016 and is now 22 months old. As for high volumes, those may simply be an indication that virtually all investor types – perhaps more than have a real reason to be there – have entered the market, and judging by recent portfolio cash levels , are fully invested.

From the behavioral side, yesterday’s third consecutive Fed rate hike this year fell on the market like a morning drizzle in the middle of summer; an hour later the ground is warm again. But the global market rally is getting long in the tooth, and the heavy monetary and geopolitical skies ahead speak of more rain to come. Perhaps storms.

The truth of it is that whether you are lifted by the memories of the recent past or depressed by worries of what is to come, you know you can alter neither. Try as you might to predict the future, it is like trying to see the sun on a rainy day. You know it is there, somewhere in the sky, but no matter how hard you stare, the most you can see is a lightening through the clouds. So, in the words of Doris Day, “what will be will be”, the question is, will you be ready for it?

 


[1] Insert here the usual legal caveat about this being my own opinion and not those of my employer…
[2] See the weekly Axioma Risk Monitor email from Dec 11 for more details.
[3] See latest BoA/ML Investor Survey.

Olivier d'Assier

Olivier d'Assier is Head of Applied Research, APAC, for Axioma and is responsible for generating unique regional insights into risk trends by leveraging and analyzing Axioma's vast data on market and portfolio risk. d'Assier's research helps clients and prospects better understand and adapt to the evolving risk environment in Asia Pacific.