Investors face a conundrum: The world is experiencing a record synchronous growth phase, but an increasing number of assets are becoming overvalued just as fundamental risks lurk in the background. Should investors continue to dance to the tune of central bank stimulus and low volatility, or prepare to exit?
What appears to be a Goldilocks economy could in actuality conceal a low-volatility trap, a situation where excessive monetary stimulus keeps asset prices rising and volatility low across markets even though real-economy risks are rising. On one hand, central bank stimulus directly lowers risk premiums and volatility in rates and credit markets, pushing investors into riskier assets to generate sufficient returns. On the other hand, politics have become less stable as inequality rises, as the recent elections in the U.S., U.K. and Europe show, and the number of geopolitical hotspots continues to rise. And yet, markets continue threading higher and volatility remains at record lows.