It’s quiet out there.
Since the so-called return of volatility at the beginning of the year, financial markets are seemingly benign once again. Perhaps it’s the warm summer in the northern hemisphere, but many investors now feel that investing in equities is less risky than it was just six months ago. Indeed, volatility, as measured by the VIX index, is once again subdued.
It is our firm belief that volatility is not a risk (we define risk as the chance of permanently losing some or all of the money you have invested). Unfortunately, most investors argue the opposite. Evidence of this argument can be found in the crusade to distil risk into a single, all-encompassing stand-alone statistic, such as ‘Value at Risk’ (VaR). This measure of risk is commonly used to estimate how much an investment may lose over a certain time period at a given level of probability. It does this by looking at the historical volatility. As a consequence, VaR shows unequivocally that the higher the volatility, the higher the risk of an investment.
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With the only certainty being uncertainty, markets have maintained their composure through the escalation of US trade developments with China.
Generally speaking, risk assets performed well in July with most global equity markets posting solid gains. Significantly, “value”, as a style factor, performed well compared to “growth”, which benefitted our core global equity holding (Schroder QEP Blend Strategy) which has an inherent value bias and which has been hurt for some time by the persistent outperformance of “growth” and “momentum” over “value”. Credit spreads retraced some of their losses with global high yield having a decent month despite relatively narrow spreads and evidence of broader fundamental and technical deterioration. While bond yields moved higher in July, our very modest duration positioning of 0.7 years helped protect the portfolio from this negative drag.
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June was a challenging month as markets were buffeted by trade war tensions. Early in the month, President Trump imposed steel and aluminium tariffs on Europe, Canada and Mexico, prompting each country to retaliate with tariffs on US products. The Trump administration also announced a $US34bn list of Chinese goods that will be subject to tariffs beginning July 6.
Diverging economic trends saw a widening gap between global central banks, with the US Federal Reserve signalling more aggression in its policy tightening, and while the European Central Bank indicated it will end its bond purchases in December, it made clear interest rates will remain at their present level until at least the middle of 2019, if not longer. The June quarter also saw Italian politics cause volatility in bond markets as anti-establishment parties formed a government.
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Markets were dominated by geopolitical events in May, driving volatility over the month. The biggest impact came from Italy where the reverberations from the March 4 election continue. A power struggle between the Eurosceptic populists — strong performers during the March election — and the President saw fears rise of another election and the potential of a populist win. This led markets to price in the risk of an Italian departure from the European Union.
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