One of the most widespread forecasts in this phase is that market volatility, now at its lowest terms, will soon begin to increase. In one sense it is an easy prediction. Something unforeseen always happens sooner or later, and arguing that nothing will happen is one of the most ill-advised statements one can make. Even in the rare event that nothing particularly significant actually happens, it is stability itself that, in the long run, breeds instability. from within. We have seen this on a large scale over the past decade, when the much-vaunted Great Moderation (stable growth, stable inflation) created excesses of all kinds in the economy and markets. We see this frequently, on a smaller scale, in financial instruments. The flat calm induces everyone to take more and more risk until the moment when it takes little to frighten and trigger stop losses that amplify market movements.
Only sector specialists and investors with small positions profit from periods of volatility. All the others, the vast majority, tend to lose out. The risk measurement and control systems in use all over the world help in their turn to lose money and opportunities, because they flash furiously when stock markets are at lows (if these are reached with rapid falls) and doze peacefully when, as now, they are on high levels achieved without tearing. In the second half of 2009 and again in 2010, the Value-at-Risk, which measures volatility on the basis of the previous 12-24 months, recommended and imposed maximum prudence precisely when you could buy anything you wanted cheaply. Today the same system, reasoning on a regular and calm recent past, leaves ample room for those who want to buy shares and bonds on historic highs. Contrary to a widespread opinion, volatility is not even a good trend indicator and does not help to forecasts. Tobias Levkovich of Citi worked on a long time series and calculated that when the Vix is between 10 and 15 (it is now at 13.40) there is an 88 percent chance that 12 months later the stock will be higher . When the Vix is between 15 and 20 the odds are 87.5 out of a hundred. And guess what the odds are of a stronger bag with a high Vix, say between 35 and 40? It's 87.5 per cent again. Volatility, therefore, is sometimes noise and sometimes a signal, but it doesn't follow rules.
What we want to propose here as a hypothesis is not that noise cannot rise in the next two-three months, which is very possible also due to seasonal circumstances, but that noise can already have signal dignity. Our reasoning starts from the volatility of the economic cycle , which is often the basis of that of the markets. As we know, America went through a phase of strong growth in the second half of last year. There has been a surge in confidence, due to increased political stability, and businesses have suddenly found that they have low inventories of products to offer to consumers. Once the warehouses were overfilled, 2014 arrived with its load of bad weather, higher charges for Obamacare and lower tax breaks for investments. GDP contracted abruptly and warehouses were emptied. When the good weather returned, consumption resumed normally but more production than usual had to be done to replenish stocks. The result was 4 percent annualized growth in the second quarter. If we average over the last four quarters and thus strip away the effects of neurotic inventory mini-cycles, we find US growth of 2.4 percent, a perfect number to have a magical combination of strong stocks and quiet bonds. What will the third quarter be like? Will he repeat the exploit of the second with his 4 percent? No, because stocks, accumulated too much in recent months, will be disposed of or will remain stable. The final result will therefore be close to the 2.4 that the markets have so liked so far. Does this mean that as long as growth remains at this magical level, we will have increasingly strong stock exchanges and bonds until the end of time? No, because at that speed unused resources are gradually depleted, first of all the unemployed, and in the long run inflation is generated.
As for stock markets, Michael Hartnett notes that US nominal GDP has increased by 2008 percent since 20, while the SP 500 has grown by 190 percent. Divergences of this kind cannot widen forever. As for bonds, the fact that Spanish bonds today yield less than American ones and that Portuguese bonds, despite the well-known difficulties of the banking sector, offer less than the dividends of European blue chips shows that even here all possible steps have already been taken.I months of Nirvana are numbered, but they are not over. The turbulence will begin if growth really accelerates (perhaps in the fourth quarter) or if, on the contrary, it weakens again. At the moment, everything points to the continuation of this irregular Goldilocks that everyone likes so much. For some weeks now, we have been recommending more aggressive portfolios to gradually lighten their equity positions and bring them back to neutral levels. However, it still seems early to adopt a markedly defensive profile. Cash yields nothing and we don't like bonds much.
Rather than chasing the governments of the European periphery to the stratospheric levels in which they find themselves, it seems more reasonable to fill up, in Europe and America, with large, healthy and calm blue-chip stocks. It is also comforting to note that the largest German insurer, the largest American airline and the best bank in the world have single-digit multiples. And, like them, many other excellent companies. When the sea starts to get rough, even the largest and most solid ships are affected by the force of the waves, but they don't sink. On the other hand, those who take refuge on any shore just because the mainland appears stable to them risk, if they have not chosen well where to stand, being overtaken and swept away by the sea. Argentina, Espirito Santo, Gaza, anti-Russian sanctions and bank fines anxiety in the markets but generate more noise than signal if they remain small and if the main engine of the global economy continues to function. Historically, single country or single bank financial crises have been buying opportunities when they have taken place in a positive macro environment.
As for Europe flirting with deflation, this is potentially a serious problem (particularly for the periphery), but two usually effective weapons are available for the foreseeable future to combat the Japanese disease. The first is the devaluation of the euro, which is set to continue. The second, which is looming more and more clearly for the end of the year, is Quantitative easing. In summary, from now on, even more than exposure to price volatility, the quality of what is invested will need to be taken care of , whether it's shares, bonds or cash (which, if deposited in the wrong place, can prove to be less secure than you think). Defensive in quality, therefore, not in quantity. Happy holidays to all.
