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Market's Numbness to Risk Reminds of Calm Before Storm: Axioma

Updated on
  • Cash positions are near 3-5% versus 20% at the start of 2017
  • U.S.-China trade war is major market risk, d’Assier says

There’s “somewhat of a numbness” to risk among investors right now that’s reminiscent of pre-crisis periods in the past, according to Olivier d’Assier, head of applied research for Asia Pacific at Axioma Inc.

Singapore-based d’Assier, who develops stress tests around various scenarios for clients of the investment risk-management firm, points to the lack of reaction to the recent jump in the Chicago Board Options Exchange’s SPX Volatility Index. The gauge, known as the VIX index, surged from 10.18 percent at the end of October to as high as 14.51 percent on Nov. 15, a three-month intraday high.

“A couple of years ago, when there was a 6, 9, 10 percent increase in the VIX Index, everybody panicked,” he said. But “nobody cared, everybody jumped in” when the measure shot up this month, d’Assier said.

D’Assier shared his views in an interview last week:

Why is the market so risk-tolerant right now?

  • “We started the year with a very, very heavy geopolitical agenda” including elections in France, Holland, Germany. “All of these things were on the agenda and all of these things had the possibility to go wrong,” because the market got Brexit and Trump’s election wrong. “Volumes kept going down until after the French elections when, suddenly, it’s OK, it’s not as bad as it could have been”
  • “Now, everybody is risk-tolerant. There’s hardly any risk-averse people in the market.” Cash positions are at 3, 4, 5 percent, compared with 20 percent at the start of the year
  • Asset declines earlier in November were due to investors looking to lock-in gains before the end of the year. “Then, they were surprised by how fast things fell” and rushed back to buy some back

Are your clients expecting volatility to pick up next year?

  • “They’re not right now: that’s what bothers me. We’ve got this feel-good feeling right now, we had active managers outperforming their benchmarks for the last 12-15 months, bonuses are coming back”
  • “We’re in active management nirvana right now” where people are seeking bigger returns driven by “greed,” because “where there’s humans greed is possible, even likely”

What are some potential tipping points in the market?

  • “Those will have to be geopolitical in nature” 
  • A U.S.-China trade war is one of the big risks. Given that there are mid-term elections in the U.S. next year, “Trump will have no problem pushing through his anti-Chinese trade agenda if he wants to” as it will be politically popular, domestically. “Picking a fight with China is not going to be a good idea”
  • Among other risks, U.K. Prime Minister Theresa May “is not so strong” and “trade negotiations on Brexit are also not happening." May is "weak -- she could fall any day”

What are some risk scenarios you’ve been stress-testing?

  • “Right now, the one thing I’m working on is a reverse-Brexit scenario. Because that’s a possibility now. If May falls and another guy comes in and reverses that”
  • Investors have also been asking about the prospect of a lame-duck U.S. president if Democrats win back their congressional majority in mid-term elections next year
  • MiFID II, which requires asset managers to pay for research separately from execution, is another concern; This might mean small companies might get less or no coverage 
  • The new rules could lead to “an unintended consequence that may hit the market in terms of creating volatility among small and mid-sized firms. We’re preparing ourselves from that by building a small-cap risk model”
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