Market Bulletin: Calm

Babson Capital
Market
Bulletin
Babson
Capital Market
Bulletin
September 2014
CALM (BEFORE THE STORM?)
There seems to be a peculiar, almost eerie, calm to
global financial markets recently. Measurements of
market volatility, including the VIX1 and MOVE2
indices, reached 52-week lows during the third quarter
and seem to have shrugged off recent market
challenges (Figure 1). The relative calm exhibited by
these markets stands in stark contrast to recent
geopolitical and economic events around the globe.
drifted lower while prices of both safe (U.S.
Treasuries) and risky assets (S&P 500) have moved
higher (Figures 2 and 3). This paradoxical action can
be confounding, yet there may be a few explanations
that can shed some light on the market’s reaction.
Risk assets, and equity markets in particular, may be
reacting to an expectation that central bank monetary
policy will continue to remain extraordinarily loose.
This could also account for the relatively low level of
volatility as the markets seem to be convinced that
central banks have their backs. The combination of
historically low interest rates and labor market slack,
which was the subject of Janet Yellen’s Jackson Hole
keynote address on August 22, 2014, have boosted
corporate profitability to record high levels. Equity
markets seem to be thinking that this favorable
backdrop will remain in place for an extended period
of time.
The ongoing struggle between Russia and the West
over the Ukraine and the financial sanctions that have
been levied should suggest additional uncertainties
over energy supplies. The recent turmoil in the
Middle East including the Israeli-Gaza conflict and
unsettling developments in Iraq and Syria should
imply an escalation of risk in financial markets. On
the economic front, we have had a run of weaker data
out of Europe and further evidence of a slowdown in
China that has prompted renewed worries over global
growth. Given the aforementioned scenarios, we
might expect higher oil and gold prices, a move
toward safe-haven currencies and a sell-off in risk
assets. Instead, global financial markets reacted nearly
the opposite of what would be expected.
Bond prices, however, could be telling a different
story. The lack of inflation pressure and a policy shift
by the U.S. Federal Reserve and Bank of England
toward a focus on rising wages as the new measure for
future rate hikes may help explain some of the decline
in bond yields. In addition, higher bond prices may be
Commodity prices including gold and oil have
FIGURE 1: VOLATILITY INDICES SUGGEST CALM
VOLATILITY INDICES
22
VIX Index - Price (Left)
MOVE Index, Basis Points (Right)
Trendline: Average from 04-Apr-88 to 04-Sep-14
Trendline: Average from 04-Apr-88 to 04-Sep-14
110
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20
100
18
90
16
80
14
12
70
10
60
50
8
Sep-13
Oct-13
N ov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
Jun-14
Jul-14
Source: FactSet as of September 4, 2014.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. It is not possible to invest directly in an Index.
1
2
The VIX Index is a measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.
The MOVE index is a yield curve weighted index of the normalized implied volatility on 1-month Treasury options.
3
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Aug-14
Babson Capital Market Bulletin
FIGURE 2: GOLD AND OIL DRIFT LOWER
GOLD AND OIL
Gold, London AM Fix ing ($/ozt) - Close (Left)
Crude Oil, Brent ($/bbl) - Close (Right)
$116
$1,400
$114
$1,350
$112
$110
$1,300
$108
$106
$1,250
$104
$102
$1,200
$100
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Source : Fa c tSet a s o f Se ptembe r 4, 2014.
reflective of an appreciation for the deteriorating
geopolitical environment and weaker macroeconomic
data that could be signaling an increase in market risk.
order for calm to prevail, it appears the optimism
about a recovery in the U.S. and global economies
needs to remain intact and the market’s faith in global
central banks does not waver. Absent this, financial
markets could be facing the calm before the storm.
OUTLOOK
A traditional view would purport that bond prices rise
and equity prices fall if the economy is expected to
weaken. A reconciliation of the opposing views we
have seen expressed in financial markets recently,
including docile volatility levels, would seem
inevitable if we are to revert to the historical norm. In
FIGURE 3: SAFE AND RISKY ASSETS RISING TOGETHER
S&P 500 AND U.S. TREASURIES
S&P 500 - Price Index (Left)
Barclays US Aggregate Government - Treasury - Price (Right)
2,000
103.5
1,950
103.0
1,900
1,850
102.5
1,800
102.0
1,750
1,700
101.5
1,650
101.0
Sep-13
Oct-13
Nov-13
Dec-13
Jan-14
Feb-14
Mar-14
Apr-14
May-14
Source: FactSet as of September 4, 2014.
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. It is not possi bl e to invest directly in an Index.
2
FOR INVESTMENT PROFESSIONALS ONLY
Jun-14
Jul-14
Aug-14
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14/1598 2014/292
SALES
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Managing Director
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EUROPE
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AUSTRALIA
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Managing Director
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Jon Millin
Managing Director
+61.2.8277.5004
[email protected]
ASIA
Giselle Lee
Managing Director
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CONSULTANTS
U.S.
David Acampora
Managing Director
+1.917.542.8375
[email protected]
EUROPE
Neil Godfrey
Managing Director
+44 (0)20 3206 4576
[email protected]
ASIA / AUSTRALIA
Sue-Ellen O’Keeffe
Managing Director
+61.3.9620.1800
[email protected]
Jon Millin
Managing Director
+61.2.8277.5004
[email protected]
3
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