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Why markets’ ‘untroubled, un-bumpy ride’ might be coming to an end
In mid-August, the market’s seemingly endless march higher was briefly halted by what most analysts attribute to the unwinding of the Japanese Yen carry trade (borrowing in Yen, which has historically had an ultra-low interest rate, to invest in typically US stocks or bonds) with the Bank of Japan hiking rates).
The resulting anxiety saw the VIX rise, the S&P fall, prompted plenty of think pieces about whether this was the ‘big one’, and left David Elms, head of diversified alternatives at Janus Henderson, somewhat bemused.
“If we look back at recent times we’re going to have people scratching their heads and asking what that was all about,” Elms tells ISN. “The VIX hitting that intraday high was one of the three biggest spikes in its history – 2008, 2020, and August 2024. August 2024, unless something very strange happens between now and the end of the month, the odd one out.”
Elms attributes it to, essentially, a small accident in Japan happening at a time of the year when senior people were on holidays and a time of day when the VIX calculation was incredibly illiquid. Everybody thought that if the VIX was that high “the world must be about to end and (so) rolled out their disaster plans”.
The parallel is likely the 2018 “volmageddon” event where VIX ETPs pretty much went to zero. Some time prior to the August event, the Janus Henderson team saw VIX calls were so cheap it “would almost be rude not to buy them” and has done well from them in August, with bets against the dispersion trade also helping out – though, as Elms notes, the month isn’t quite over yet. But while the August volmageddon might be a headscratcher, it’s Elms’ expectation that there will be more events like it as markets’ “untroubled, un-bumpy ride” comes to an end.
“You haven’t gotten the mispricing that creates a lot of opportunities,” Elms says. “So now that we’re starting to get some sense that is maybe at an end with more geopolitical risk coming in, and uncertainty about monetary policy because there’s a hint of recession out there. These sort of things create pockets of opportunity.”
“If we see a levelling off of the last couple of years of strong equities and strong credit, then alternatives a) become more relevant to clients but and b) the opportunity set for those alternative strategies probably gets better as well. In an ideal world you’re producing returns for clients at a time when they need those returns.”
The geopolitical events that we’ve seen haven’t distorted markets much, which Elms believes is down to desensitisation. A decade ago a Chinese patrol boat ramming a Filipino patrol boat might have caused at least a minor hiccup in equity markets.
“The scenario is probably more the straw that broke the camel’s back,” Elms says. “Because we’ve been desensitised to it with everything that’s going on in the Ukraine, everything that’s going on in the Middle-East, the response that markets used to have, to pay attention to it, is lacking… What you may have is something that in of itself appears minor but just bumps the world’s risk tolerance beyond comfortable levels.”
Though the difficulty for some investors is not so much recognising that geopolitics is a risk but a question of how to trade that risk. The answer isn’t in any one asset but perhaps in understanding – in a practical sense, at a portfolio level – that good times don’t last.
“Just because it’s difficult to trade doesn’t mean this stuff is irrelevant,” Elms says. “There is a point at which geopolitics becomes absolutely critical and it’s very hard to know when that comes and what you need to do is have protection in your portfolio.”
“Russia hasn’t been invaded since the second World War; who knows how they’ll respond to that, particularly if it threatens Putin politically? You’ve got an election in the US where we have a candidate that is probably now a mild favourite in a polling sense who wasn’t even a candidate a few weeks back. There’s a lot of things going on, and it’s easy to think that asset prices go up all the time. They don’t.”
