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Investment Committee: Elizabeth Savage, Rathbones

Investment Committee: Elizabeth Savage, Rathbones

Rathbones' head of research discusses volatility in global equity markets. 

'Despite increasingly worrying populism and rising geopolitical risk over the past year, equity market volatility has steadily fallen to near record lows.

The Vix index, which measures implied volatility of the S&P 500 (what investors expect it will be in the future) is at 9.8. That’s extremely low, but even at those depths it’s undershooting realised volatility (what actually happens).

And this is not just an American phenomenon – it’s global.

Over the last three months, the annualised volatility of the MSCI Word Index was 6.1%. To put that in context, global equity volatility has averaged almost 15% over the last 25 years.

Markets seem relatively sanguine in the face of the populism being stirred up in the West by stagnant wages. Similarly, markets imply that rising tensions in Asia and Eastern Europe will either fizzle out or have little effect on investment returns.

Even the steady tightening of US interest rate policy has little reign over equity prices, while European equities are still appreciating despite the belief that the European Central Bank could soon start reducing the amount of bonds it buys for its quantitative easing programme.

Could this lower volatility be a symptom of modern markets? With ever more money flowing into index-trackers and the proliferation of high-frequency traders and quant funds, could they be creating self-reinforcing feedback loops?

Maybe this increased dependency on momentum is making markets swing from exceptionally calm periods to volatile periods that are very wild indeed.

Volatility will return to equity markets, but given the indifference investors have shown to politics and the risk of war, what could trigger it?

We think a sustained slowdown in consumer spending would probably break the market’s confidence. In the US and UK consumption remains strong. However, while unemployment continues to fall, wages are still stubbornly flat after inflation.

Many households, on both sides of the Atlantic, have been funding their spending with increasing amounts of debt. For years, poor wage growth has been offset by soaring house prices that have kept people feeling flush. In the UK, this upward trend in values has started to cough a bit in recent months. We do not believe a consumption squeeze is happening yet, but are keeping a careful eye on these bellwethers of spending, both in the UK and America.

For instance, US auto-loans have now surpassed $1 trillion, having been building for years. Car companies have been selling cars on finance to people with poor credit before bundling the loans up into asset-backed securities and passing them on to investors, leading to comparisons to the subprime property bubble in the mid 2000s.

Less is said about educational debt in the US, which now totals $1.4 trillion. Default rates are rising rapidly here. Borrowing to fund education should be a good thing: it adds skills to the economy and leads to better pay for the graduate. In theory. If that is the case, why have productivity and wages in the US remained so poor? The same can be said for the UK, where education costs are also rising rapidly.

For those people who do not default, burdensome loans are becoming more difficult to service. We could be facing a whole generation whose consumption is constrained by their university debt.

The global economy is ticking along well at the moment, but there are plenty of dynamics that we think deserve scrutiny now. Because when volatility returns, they will quickly be front and centre in worried investors’ minds.'

If you would like to be on our next Investment Committee panel, email Eleanor on emahmoud@citywire.co.uk.

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