October's Wild Ride Isn't Over Yet
The first half of October and particularly the last five days and today have been brutal for investors who had bought into the notion of the low-volatility "Goldilocks" economy and markets. They have experienced large losses on their highly correlated positions in different asset classes. Indeed, with the exception of government bonds -- a generally unappreciated asset class until recently -- they have found few if any shelters from the storm. And the market choppiness is likely to continue for what many will feel is an uncomfortably long period of time.
For quite a while now, too many investors have been comforted by two intoxicating notions: that the global economy would continue in a low-growth equilibrium, thus avoiding both a recession and an inflationary boom, and that central banks would succeed in repressing market volatility, not just pre-emptively but also after the fact should an unanticipated event occur. Together, these perceptions encouraged large across-the-board risk-taking that, in many instances, lost sight of fundamental valuations, liquidity realities and unbalanced market positioning.
Both notions have come under pressure in the last two weeks, simultaneously and significantly.
Poor data out of Europe and, earlier today, the U.S. highlighted the downside growth and deflation risks facing the global economy, as did the rush of unfavorable revisions for 2014-2015 projections by the International Monetary Fund, the Organization for Economic Cooperation and Development, the World Bank and Germany, Europe's powerhouse. Concurrently, traders' confidence in the willingness of central banks to repress market volatility was shaken by the difficulties the European Central Bank faced in being more accommodative, given signs of both internal and external opposition.
Today's moves in asset prices would not have been so dramatic had markets not been so overly optimistic in their positioning. But they were. And the resulting price volatility was dramatic in virtually every asset class.
In such wild markets, a growing number of traders received that dreaded tap on the shoulder from risk managers to exit positions regardless of liquidity. And that liquidity was patchy to begin with given that broker-dealers have little appetite for risk these days. The result has been multiplying technical disruptions.
How about the outlook?
Given where we are coming from, this technical phase will not dissipate quickly. Though unlikely to be as dramatic as today, market volatility can be expected to continue in the days and weeks to come as two forces compete: first, the forced deleveraging of certain investors, particularly overstretched hedge funds registering big October losses; second, central banks scrambling to say all sorts of reassuring things. All of this will serve to reinforce October's longstanding reputation as a threatening month for investors around the world.
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