If we only had the published macro data of the US and Eurozone to go by, we would probably have concluded that August was a boring month: most economic data published was in line with expectations, showing a path of steady growth. Of course, this conclusion would have been completely wrong, as the end of the month was marked by a huge increase in volatility.
Stocks declined by as much as 10% in four trading sessions, the term ‘Black Monday’ was re-coined, the euro and yen spiked versus all other currencies, while oil dropped and then rebounded by more than 25% in three days of trading.
The source of all this volatility was the uncertainty about the economic prospects of the world’s second-largest economy, China. The ongoing collapse of Chinese stocks, the country’s weak export and PMI numbers and the unexpected devaluation of the yuan, raised doubts about the level of central government control. We broadly disagree, and are now in the process adding back the risk-tilt into our portfolios which we had reduced during the early part of the summer.
Volatility is probably going to remain high for some time to come, and it is certainly not the case that stocks have become cheap again. But because of the recent developments, the risk/reward ratio for equities has now become interesting again. As for bonds, although we remain neutral, we are changing our base case, as we now have a bias for rates to move higher.
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