Recent complacency in financial markets

  • Deutsche Bank: predicts S&P 500 has had 10 out of 11 days with a move of less than 0.2%, the quietest period since 1927
  • The volatility index (Vix) fell to a 23 year low after the French election result – a striking contrast to the political turmoil of the Trump administration, North Korea tensions, and the firing of the FBI director.
  • Previous low Vix preceded trouble: December 1993 – followed by a great bond sell-off after the Federal Reserve started to tighten policy in January 1994.
  • Vix measures: the price, as derived from the options market, that investors are willing to pay to insure themselves against a sharp move in asset prices. It is implied volatility, and is predominantly determined by realised volatility.
  • Battle between those who belief that the ‘reflation trade’ which preceded the election of Donald Trump, still has momentum, and those who believe there is still trouble ahead.
    • reflation trade: the way prices will change if investors start to put money behind the view that growth and inflation will rise.
    • Reflation: a fiscal/monetary policy designed to expand a country’s output and curb the effects of deflation – include reducing taxes, changing the money supply and lowering interest rates.
  • Commodity prices have fallen 7.3% since their recent high in February, potentially indicative of a slow down in the Chinese economu
  • Goldman Sach’s current activity for China slowed to 6.4% annualised in April from 7.6% in March on the back of higher interest rates, and slower growth in credit and the money supply.
  • Risk: Chinese growth shows up in slower commodity demand (which hits emerging markets the most) and a weaker currency (which hits manufacturers in developed economies)
  • Valuations are incredibly high – American equities are as high as they were in 2007

Positive outlooks:

  • Some people take opposite view: Mark Tinker of Axa Investment Managers ‘there has been a misplaced emphasis on short-term indicators and particularly on measure such as debt to GDP’
  • UBS spokesperson: while Chinese depreciation is a serious deflationary risk for the global economy, the authorities seem to have gone to great length to prevent capital from flowing out of the country and triggering a sell off.
  • Morgan Stanley spokesperson: Chinese are tightening at a time of accelerating global growth ‘the key reason why this cycle should be different is that the external demand environment has improved significantly. Indeed, we expect 2017 to be the best year for exports growth for China since 2013.’
  • Capital Economics: shows that emerging market export growth reached 13.9% in March, the fastest increase since 2012. While it is largely a value effect, volumes are up 3.2% year-on-year.
  • No sign of distress in the corporate bond market which many, including David Ranson of HCWE Economics, see as an early warning indicator
  • Global default rate for speculative bonds over the last 12 months fell to 3.6%, according to Moody’s; a year ago it was 4.3%.
  • In America, the default rate is down to 38%, from 5.1% at the end of 2016
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