Volatility rears its head… briefly

The month of August has proven to be one of the most volatile months in share markets in over 4 years with both the Dow Jones Industrial and S&P 500 both producing five days in the month where they both rose or fell by over 2%.

The volatility has been blamed on the drop in the Shanghai Composite, but the reality is that this might only apply the Chinese and Emerging markets. For the volatility seen in the US the catalyst was thought to be the next stage of the “Taper Tantrum” as the markets now priced in the expectation of the US Federal Open Monetary Committee (the Fed) increasing interest rates for the first time in over 6.5 years.

There is little doubt that the markets initially got nervous about the drop in the Shanghai Composite, which has now dropped by over 39% since its high in June 15. This massive increase in volatility has led investors to finally start to review the pricing of risk in the markets, and hence we saw the S&P500 also drop by around 12% over one week in August before rebounding by 6.5% the following week.

 

Chart 1 – Shanghai Composite

Shanghai Composite

Chart 2 – US S&P500

 S&P 500

Volatility Index

VIX

Source: Bloomberg.com

 

 

 

The “Tapper Tantrum” alludes to markets becoming more volatile as fund managers start to price in any change of the Feds support in the bond markets. We last saw a similar “tantrum” when the Fed ceased adding further funds in their most recent round of Quantitate Easing (QE). More recently, as the Fed and other central banks have moved to support lower interest rates for longer, investors have moved into higher yielding markets, such as some of the BRICK countries.

This has added greater risk to clients’ portfolios, without a commiserate increase in returns, and as we get closer to the Feds “lift off” date (increasing the interest rates), funds have now flown from the emerging markets back to the “safe haven” of the US markets. The removal of capital from emerging markets did not just have a negative impact on emerging share markets, but also emerging bond markets, as the higher yields bonds were sold into a reasonably illiquid market.

Fund managers withdrawal of capital from emerging market economies has been further encouraged by oil prices, which continued to slump on the news that China’s growth was slowing. This drop in demand has led to an increase in oversupply, as the US and Middle East continues to produce excessive levels of oil. At present crude oil is trading at $49.56, which is down from $114.81 seen in the middle of 2014.

Varied index performance – ending 31st Aug 2015

returns

Source: Craigs Investment Partners All returns Aug 2015 report.