By continuing on this site you have agreed to cookies being placed and accessed by this website. More information and adjusting cookie settings.

Robeco uses cookies to analyze your visit to this site, to share information via social media and to personalize the site and advertisements in line with your own preferences. By clicking on agree or by continuing on this site, you agree to the above. More information and adjusting cookie settings.

AGREE

Robeco uses cookies to analyze your visit to this site, to share information via social media and to personalize the site and advertisements in line with your own preferences. By clicking on agree or by continuing on this site, you agree to the above. More information and adjusting cookie settings.

AGREE

By continuing on this site you have agreed to cookies being placed and accessed by this website. More information and adjusting cookie settings.

Taking some risk off the table

09-10-2014 | News item | Peter van der Welle Low volatility would normally be welcomed by investors – but a sustained period can also act as a warning shot for impeding market volatility, Robeco’s strategist says.

Speed read:

  • Low volatility period similar to before 2013 market wobble
  • Weightings cut in equities by Robeco Asset Allocation
  • Divergence within equity markets a key reason
  • Uneven global economic recovery also not helping

Worries that the long bull run in equity markets may be confronted with headwinds have prompted Robeco Asset Allocation to take some risk off the table by reducing the size of its tactical overweight in equities.

Research this month by the Federal Reserve Bank of New York looked at the drivers behind the current period of low volatility and observed that over the last few decades there have been only two other similar periods. These were in May 2013, just before the Fed warned that tapering would begin, causing several markets to tumble, and prior to the financial crisis in 2007. Although the Fed authors note striking differences with what happened in 2007, they conclude that the current environment does resemble the May 2013 episode.

At an inflection point
“We think we are at an inflection point where different regional growth trajectories and events, combined with less excess liquidity, will also lead to different policy reactions with different market implications, raising market uncertainty,” says Peter van der Welle.

“Although we do not expect major market events, there are several reasons that make us more cautious on risky assets in the near term. So this month we have taken some risk off the table.

“We think that risks (and thus volatility) are becoming more prevalent in an uneven global recovery. With increased market risk around the corner, we prefer a less aggressive tactical profile.”

taking-some-risk-of-the-table.jpg 
Robeco Asset Allocation: our positions at October 2014.

‘We prefer a less aggressive tactical profile’

Reasons for tactical changes
Van der Welle says there are several reasons why markets might be heading for a wobble: declining momentum in equity markets, divergence between small and large cap stocks, divergence in monetary policy; the uneven global economic recovery; the recent spread widening in the high yield market, and unwelcome geopolitical factors.

One possible signal is the fact that small cap stocks – which are perceived as being more risky by investors – have lagged the performance of large caps. This observation is confirmed in the US, where the performance of cyclical stocks has lagged that of defensives, even though the macroeconomic environment suggests cyclicals should be the ones outperforming.

But the bigger problem is the world’s central banks doing different things, he says. “The divergence in monetary policy is more apparent than it was a couple of months ago,” says the strategist. “The Fed will soon end bond purchases, and is contemplating raising rates, while the European Central Bank is doing the opposite.”

“The Fed has already hinted that rates will start rising in 2015, and chairwoman Janet Yellen has adopted a more hawkish tone that has increased uncertainty about the Fed hiking path.”

Next Fed meeting is key
Van der Welle says much depends on what happens at the next Fed meeting on 29 October. “Volatility could remain elevated if the Fed drops the phrase that rates ‘will remain low for a considerable time’,” he says. “This would suggest an increased probability of an earlier hike while the inflation environment is still benign.”

Furthermore, the Fed will no longer expand its balance sheet from November onwards when tapering ends and it stops the additional buying of Treasuries. The recent history of quantitative easing shows that the ending of unconventional policies has typically brought elevated volatility in the surrounding months, Van der Welle warns. 

‘The divergence in monetary policy is now more apparent’

“Meanwhile divergence in monetary policy has increased as the ECB has announced it may increase its balance sheet over a period of two years by EUR 1 trillion through acquiring asset backed securities and covered bonds,” he says. Cheap funding will also be provided to banks via the Targeted Long-Term Refinancing Operations (TLTROs), though disagreements within the ECB and with Germany do not guarantee that the massive funding flows will take place.

The unevenness of the global economy recovery also threatens future market stability, Van der Welle says. “Although the US is performing well, other regions continue to disappoint,” he says. “Macro momentum in Europe has slowed as consumer and producer sentiment has worsened considerably. And the economy in Japan has disappointed as the country needs to reignite the ‘third pillar of Abenomics’ with structural reforms.”

Higher spreads in high yield
Another factor to bear in mind is the higher spreads that have been seen in the corporate high yield market. “These spreads tend to correlate closely with perceived financial stress, so this is another reason to take a more cautious stance towards equities,” says Van der Welle.

Finally, geopolitical factors are worrying markets, as seen in Citigroup’s ‘news-implied sentiment indicator’, which has turned negative. The Ukraine crisis has simmered down, but the Middle East war has flared up again with US air strikes on the Islamic State group, while pro-democracy protests in Hong Kong, which could be forcibly brought to an end, are troubling China.

Share this page:


Related articles