Another month of rising bond yields continued to put pressure on equity valuations. Three month US treasury bills (as about as risk free an asset as you can find) yielded more than core inflation in the US for the first time since 2007. In the intervening period investors in cash have been penalised 1.5-2% annually by inflation. Now, once again, investing in (USD) cash generates a positive real return.
This continues our theme of QE switching to QT; QE’s purpose was to force money out of risk-free assets (by reducing their yields and so making them less attractive) and into more risky assets. QT, definitionally, should do the opposite. As QT progresses, we should see the riskiest assets (high growth, but loss-making companies) sell off the most. There should be a movement of money from high growth equities to value equities (a reversal of a years-long trend) and finally into risk-free assets. We saw the beginnings of this process during October, but the tectonic plates of QT are likely to continue to drift, with occasional earthquakes.
“If QE forced money out of risk-free assets into more risky assets, QT, definitionally, should do the opposite. With the US leading the cycle transition from QE to QT, risk-free assets are looking more and more attractive. Focusing on the 2 year bond as a measure of “risk-free” return, 3% is starting to look enticing. As QT progresses, we should see the riskiest assets become increasingly less attractive with a growing risk of a deep correction."
“The spread between US and German 2 year bond yields is at a post-1989 high. Since the late 1990’, whenever the spread has reached more than 2%, equity markets have subsequently sold off, and whenever it has gone negative, equity markets have subsequently rallied. With the spread now over 3.4%, we’re 2 years late for a sell-off, by this measure. Food for thought at least.”
Is the US equity market overheating?
Subdued volatility points to a certain complacency, however the current term structure of implied volatility indicates that the tail risk has considerably increased over the last few weeks and remains close to historical highs.
To add to the two mini-crises this year: the inverse VIX meltdown in February, and more recently the Italian potential-euro-exit in May, we can now add a bear market in Chinese equities. The last is easily ascribed to Donald Trump’s talk of a trade war, but probably too easily; it more likely has its roots in a cooling Chinese consumer. As we said last month, real negative news is actually negatively impacting asset prices (as it should, but didn’t, in 2017); we still see this as positive. What concerns us slightly more is that these incidents tend to be contained to small pockets of assets (VIX to equities, Italy to Italian bonds). What we haven’t seen since late 2015, is a broad-based sell-off, predicated e.g. on falling growth expectations (a la 2015/16), or simply just valuation (1999/2000).
We are also wary of the potential for a big carry trade emerging in euro/dollar, as economic growth and interest rate policies continue to diverge. At 2 year maturities, the spread between the two has progressively widened up to 3.2% now. Unhedged carry trades must be starting to look tempting, particularly as the dollar has rallied against the euro for most of this year. This process in itself can further strengthen the dollar. But ultimately when the trade gets too crowded and/or the yield differential narrows it can all reverse. One to watch.
Our Joint Venture Rsquare (combining Arkus and BeeAM) just received the certification from Finance innovation.
We’ve now seen two mini-crises this year: the inverse VIX meltdown in February, and more recently the Italian potential-euro-exit last month. We make two observations: first, in both cases real negative news actually negatively impacted asset prices, as it should, but didn’t in 2017. We take this as positive. Second, the impact was remarkably contained: in the first case almost entirely to equities, and in the second to Italian bonds and equities, and to a lesser extent the euro. What we haven’t seen this year, in fact haven’t seen since late 2015, is a broad-based sell-off, despite several potential causes (trade war, North Korea). We are a little more concerned by this: markets seem slightly too complacent to us.
As eurozone PMI’s and GDP estimates have eased recently, we could also expect a slower exit from QE by the ECB, which should remain supportive of asset prices. The US economy remains strong though, so we might expect to see increasing divergence in inflation and bond yields, and possibly an even stronger dollar. But overall we see less reason to expect higher volatility in the next month or so.
Evolution, not revolution
Evolution, not revolution.
Disruption» is probably one the most used buzz words over the past few
years. Disruption of business models, disruption of traditional market segments, and disruption in finance is a common subject of many articles and conferences. In that respect, disruption is often associated to radical innovation. But is it really the case? Is radical innovation the only way to innovate? And what is the aim of innovation, disrupting or brings progress? And for entrepreneurs and even well-established companies, how to handle this fast-moving environment and take advantage of it?
Leading Edge Conference in London
Starting 3rd of October, Arkus will be one of the main sponsors at the next Leading Edge Conference in London!
Martin Ewen, Chief Operating Officer, will be one of the speakers and would be delighted to meet you on-site.
Quantitative Finance Symposium
Arkus is proud to sponsor the first Quantitative Finance Symposium “QuattroPole++” at Trier University, October 13th, 2015.
Séminaire Private Equity
Mercredi 28 Octobre 2015 - Luxembourg (Plus d'information à venir)
2 ans après la transposition de la directive AIFM, quel est le bilan ? Quelles sont les best practices ?
Quelles opportunités pour la distribution transfrontalière de fonds alternatifs ? - Résumé et photos de l'événement
Petit-déjeuner de travail
Jeudi 18 Juin 2015 de 8h30 à 10h30
Swissotel Métropole Genève
IFBL Risk training
Thursday 04/06/2015 - IFBL
Axelle Ferey, General Manager at Arkus Financial Services facilitated an IFBL training on the following subject: "Understanding Business Processes and Controls in Private Equity"
European Risk Management Conference - Highlights and photos
Chamber of Commerce, Kirchberg, Luxembourg
Did you miss the ALFI/ALRiM European Risk Management Conference? Check out the highlights and photos here.
Operational Real Estate, PERE & Debt Fund Management Conference
Parc Plaza - Central Luxembourg
The 11th Annual Real Estate Fund Servicing Conference - Operational Real Estate, PERE & Debt Fund Management
Risk Assessing, Monitoring & Reporting under AIFMD to Regulators & Investors
Formation - Reporting sous AIFM
Private Equity - Comment le Luxembourg renforce-t-il son positionnement sur ce marché concurrentiel ?
DoubleTree by Hilton, Luxembourg
Conference - AIFMD one year after
September 18th & 19th 2014
Hilton – St. Julian’s Bay – Malta