Read Axioma’s informed perspectives on the status of different potential risk sources around the globe.
Equity markets around the world had a strong run in the second quarter, with major indices hitting fresh records and contributing to the global rally in the first-half. Against a backdrop of geopolitical tensions, the tumult at the White House, the elections in the UK, the Netherlands and France, the downgrading of China’s debt, central banks signaling the liquidity spigot could be turned off, etc., stock markets kept eerily calm. Risk forecasts for major benchmarks sunk to at least 10-year lows. This report delves into the sources of risk worldwide, both those that contributed to the continued risk downturn and those that bucked the trend.
Stocks around the globe extended their post-election rally into the first quarter of 2017. Prospects of tax cuts and increased government spending, together with strong economic signals in the US, drove investors’ optimism up and pushed US benchmarks to fresh records. Most notably, the Dow Jones Industrial Average exceeded the 20,000 milestone in January and topped 21,000 in March, while the S&P 500 posted its largest quarterly gain since the end of 2015.
2016 was a year of surprises. The precipitous decline of the Chinese market in January pushed most major benchmarks’ returns down and sent risk to the highest levels of the year. While markets rebounded and their volatilities receded for most of the second quarter, stocks dropped again and indices experienced another spike in risk following the unexpected result of the UK referendum at the end of June. This drop, however, was short lived, and markets rebounded quickly. Equity markets have posted strong gains since Nov. 8, and the year concluded with multiple benchmark returns in the black, some at record highs, while volatilities remained relatively low.
By the time the third quarter rolled around, markets were experiencing periods of both severe unrest and eerie calm. The initial shock of the Brexit vote sent equity market volatilities and correlations to new heights in July. But Brexit concerns faded rapidly. Asset correlations made a U-turn by the end of July and in most regions risk forecasts fell to their lowest levels since the summer of 2015 by quarter-end. The summer months were otherwise relatively calm, with trading activity slowing down greatly in August. Large swings in oil prices continued.
At the outset, and for most of the second quarter, it appeared risk was re-entering a relatively benign period. Many components of risk (market, country, currency, style) had fallen in aggregate (of course, not all individual countries, currencies or styles followed suit). But two relatively unexpected events served to shatter the calm – a sudden spike in oil prices, which seemed to have the biggest impact on Canada but was felt elsewhere as well, and, of course, the vote by citizens of the UK to leave the European Union.
Markets experienced sharp increases in risk during the first quarter, with most, if not all, components of risk contributing to the increase. Global market risk ended the quarter higher than it has been since 2012, although clearly well below the levels seen during recent crises, including the global financial crisis and the European debt crisis. Factor volatilities – country, currency, industry, style – all rose, some quite substantially, with some reaching the top quartile or higher of risk relative to historical levels. Correlations between factors were mixed, with some lower correlations serving to dampen the impact of higher volatility, at least slightly. Correlations across asset classes also saw a few large changes.