A Storm In a Tea Cup !

Ok it has been a couple of eventful weeks if you were invested in equities be them from developed markets or emerging markets. Clearly the scaremongering of analysts and journalists paid by the line rather than the true profit they generate has somehow fed into the volatility and sudden lack of rationale of markets. We have seen a spike in the VIX and  as indicated by a 2-state Markov regime switching model a risk off scenario. As mentioned in my previous post, it is worth bearing in mind that those periods of risk aversion tend to be short and somehow provide good ground for opportunities.vixregimes

True  the sell off  somehow pushed most equity markets in the red. But if one take time to look at the moves that unfolded they have not been really out of tune from what could be expected from the median risk of equity markets. By that I mean that if you assume that equity markets have  typically an annualised volatility of 20% this means that the monthly move expected  under a normal distribution assumption should be tantamount to 20% * 1.6450 /sqrt(12) = +/- 9% . So true enough some of the markets such as Japan and Chile have gone  somehow out of this range as shown in the below chart. But I would argue that we are not miles away and that there is no reason to panic because  a herd of unknown analysts have come out from the woodworks forecasting the end of the world as we know it…..a loss of nerves is is to be expected every time we have a down move of more than 5%.

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In respect of the S&P500  the move we have seen over the last 21 days is indeed pretty much middle of the road as a close neighbour analysis using daily data back to 1980 demonstrates. From there the scenarios are quite varied…

pattern

So let’s go back to the catalyst of those financial ripples, the Fed policy an its impact on global liquidity. Well , there is nothing new about the Fed reducing its liquidity supply. We have been told last year what was the plan and you are better getting use to it ! Bottom line is that things are going very well in the US, the data is clearly indicating a strong recovery which is logically feeding into both the housing markets and the equity markets. So it may well be that the liquidity which is smoothly withdrawn  by the fed will in fact be replaced by investment flows and a growing trading activity between the developed world and emerging market countries as those economies recover and re-leverage. Perversely this could have a negative effect on the dollar as it will mean more cross border flow toward new international opportunities by US investors and corporates. Also as  growth come back and US withdraw some of its liquidity it is likely that some of the EM countries will draw on there reserves  which is predominantly made of US$ to stimulate their own economies. Anyhow it is worth looking at the latest batch of data on inflow in US Mutual funds as it now cover the recent period of volatility.

inflowversus VIXflowmap

And guess what…. investors are still buying international and domestic equities significantly. Bonds flows have somehow recovered ever so slightly….though my view is that they will probably shift back to negative for the reasons presented in my previous posts…..So I think I ll keep re-investing those dividends in financial equities for a while..