Geert Wilder’s anti-EU party’s failure to take control in the recent Dutch elections is clearly a positive development. Nonetheless, one cannot say this is an effective bellwether for the upcoming French Presidential race. While we believe the French elections might well be the entry point back into equity markets (particularly Europe), it is still too early to make that call.
Moreover, the political impasse in the US over Obamacare, government funding and the potential tax reform have, in our view, the potential to disappoint equity markets even further.
Volatility measures point to market complacency
Within equity markets, the only segment that has appeared to be attractively valued is volatility. Up until late March levels of implied equity volatility were as low as they have been in years. The VSTOXX, which is the index that gauges European equity volatility, tumbled post the Dutch elections to a level of 11.2 per cent, the lowest level in the history of this index.
One can argue this measure of volatility is somewhat inaccurate given the options, which have exercise levels far away from the prevailing equity index level, are overrepresented in this volatility measure. Nonetheless, even when looking at the implied volatility levels of options close to their exercise price, it becomes clear that volatility is cheap.
The generic measure of implied volatility of one month at the money options went also as low as 12 per cent. Similar observations of cheap equity volatility can be found in the US with the VIX troughing at 10.6 per cent in January, in Japan with the VXJ index bottoming at 14.5 per cent and in emerging markets with the VXEEM index at 14% in early March.
Since the defeat of Donald Trump over his plan to repeal and replace Obama care, which was one of his election promises, all of the aforementioned equity volatility measures have clearly started to edge higher. Yet they remain at very low levels, continuing to suggest a fair level of complacency around potential risks by market participants.
Treasuries may have bottomed out in near-term
When it comes to duration, our view remains intact: bond markets are expensive and central banks are shifting into a less accommodative stance. The fact that bond investors reacted positively to the interest rate hike by the Fed mid-March is a good sign, but it is as much testament to the Fed’s ability to manage expectations. We are mindful the ECB and the Bank of Japan might eventually be forced to change their dovish narrative.
We remain concerned about bond valuations. However, mid-March’s rally in the US government bond markets is evident that, in the very near term, treasuries seem to have bottomed out.
Moreover, the political showdown unfolding in the US, and the fact that US inflation pressures and growth momentum is likely to roll over given base effects, would suggest an at least stable environment for US bonds here onwards. Hence our relative preference for Treasuries over other bond markets. Yet, longer term there remains a significant question mark over the sustainability of current government bond yield levels.
Political risks remain underestimated in Europe, and the fact that the ECB and the Bank of Japan will eventually have to become hawkish, is likely to present a headwind to bond markets. Namely Japanese government bonds are vulnerable to a repricing, given that they have barely moved since the US election. Hence our change in assessment.
Cash remains king
In the present environment, cash remains king. Moreover, the USD trade finally seems to have turned. We have mentioned the fact that the strength in USD appears to be overdone for many months now, yet the US dollar continued to climb on expectations of interest rate hikes by the Fed and on hope of higher US growth induced by Donald Trump’s reflationary policy agenda.
With the Fed, having delivered a rate hike earlier than anticipated by markets and, with Donald Trump facing his first stumble on implementing his policy changes, the US dollar went into freefall. We expect this to continue and maybe even to accelerate as other western central banks start to reassess their monetary stance.
Hartwig Kos, co-head of multi-asset at SYZ Asset Management