Low volatility the new normal?

  • 06 Feb 2018
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Low volatility the new normal?

After an extraordinary period of extremely low volatility, with the US not seeing any sort of correction for the last 12 months and other share markets trying to follow suite, Goldilocks might have woken the Bond Bears from their 30 year slumber.

As you know Goldilocks liked things not too hot and not too cold. Nicely growing economies, with no inflationary pressures, so low interest rates.

For most of the month it was all about profit growth and expanding economies. The slow upward drift accelerated as optimism grew. Bumper profits were reported in the US and the shadows of the GFC were at last fading. However, at the end of the month, investors remembered that the other side of stronger growth is higher interest rates. Maybe inflation will not stay at record lows forever?

These competing forces are the major macro factors impacting on markets. If inflation and interest rates do increase, you want to make sure that the income your investments can generate also increases. Strong economic growth can allow for profits to rise. However, the darlings of the past decade, reliable income producers, can really struggle. This includes utilities, property trusts, and some defensive income producing stocks. With the collapse in interest rates these investments have become very expensive, relative to history. As they have less ability to increase income, in a strengthening economy, with rising rates their capital values are under threat.

We have seen periods when the market expected rates to rise before, only to be baffled by the lack of wage growth and inflation. Interest expectations rose and then fell back again, as inflation did not materialise. While, the Amazons of the world, globalisation and mechanisation are keeping prices much lower than they otherwise would be, it will only take a bit of a rise in long term rates to shake some valuations. We do not know the future, however we know what markets are assuming and when they become too sure of their expectations, something comes along to change things.

That is why positioning will always “trump” predictions over time and is the wiser investment approach.

For further information or to discuss how we can help you, please speak to your advisor.