CLOSE

We permit the publication of our auditors’ report, provided the report is published in full only and is accompanied by the full financial statements to which our auditors’ report relates, and is only published on an access-controlled page on your website https://www.hermes-investment.com, to enable users to verify that an auditors’ report by independent accountants has been commissioned by the directors and issued. Such permission to publish is given by us without accepting or assuming any responsibility or liability to any third party users save where we have agreed terms with them in writing.

Our consent is given on condition that before any third party accesses our auditors’ report via the webpage they first document their agreement to the following terms of access to our report via a click-through webpage with an 'I accept' button. The terms to be included on your website are as follows:

I accept and agree for and on behalf of myself and the Trust I represent (each a "recipient") that:

  1. PricewaterhouseCoopers LLP (“PwC”) accepts no liability (including liability for negligence) to each recipient in relation to PwC’s report. The report is provided to each recipient for information purposes only. If a recipient relies on PwC’s report, it does so entirely at its own risk;
  2. No recipient will bring a claim against PwC which relates to the access to the report by a recipient;
  3. Neither PwC’s report, nor information obtained from it, may be made available to anyone else without PwC’s prior written consent, except where required by law or regulation; and
  4. PwC’s report was prepared with Hermes Property Unit Trust's interests in mind. It was not prepared with any recipient's interests in mind or for its use. PwC’s report is not a substitute for any enquiries that a recipient should make. The financial statements are as at 25 March 2017, and thus PwC’s auditors’ report is based on historical information. Any projection of such information or PwC’s opinion thereon to future periods is subject to the risk that changes may occur after the reports are issued and the description of controls may no longer accurately portray the system of internal control. For these reasons, such projection of information to future periods would be inappropriate.
  5. PwC will be entitled to the benefit of and to enforce these terms.
I accept
CLOSE

1. Select your country

  • United Kingdom
  • Austria
  • Australia
  • Belgium
  • Denmark
  • Finland
  • France
  • Germany
  • Iceland
  • Ireland
  • Italy
  • Luxembourg
  • Netherlands
  • Norway
  • Singapore
  • Spain
  • Sweden
  • Switzerland
  • USA
  • Other

2. Select your investor type

  • Financial Advisor
  • Discretionary Investment Manager
  • Wealth Manager
  • Family Office
  • Institutional Investor
  • Investment Consultant
  • Charity, Foundation & Endowment Investor
  • Retail Investor
  • Press
  • None of the above

3. Accept our terms and conditions

By clicking Proceed I confirm I have read the important information and agree to the terms of use.

Proceed

The Hermes Investment Management website uses cookies to remember your preferences and help us improve the site.
By proceeding, you agree to cookies being placed on your computer.
Read our privacy and cookie policy.

Why relaxed investors could soon feel the heat

Home / Perspectives / Why relaxed investors could soon feel the heat

Eoin Murray, Head of Investment
22 August 2017
Risk

Markets are running hot in 2017 and markets are apparently cool with this. The complacent mood was recently jolted as the VIX spiked at its highest levels since the election of President Trump in November last year, but amidst geopolitical turmoil, calm has seemingly returned again to the markets. Here we check the temperature gauges for accuracy and identify potential risks that investors should consider as we progress through the third quarter.

Every week the St Louis Fed measures the degree of financial stress in US markets through an index that combines 18 different financial variables – seven relate to interest rates, six to yield spreads, and five others – into a single metric. For some time now, this gauge, called the St Louis Fed Financial Stress Index, has found that investors are relaxed.

Given the importance of the US to markets worldwide, the index also serves as a reasonable proxy for global conditions. Apart from the intensity of the immediate aftermath of the global financial crisis (GFC) and a brief rally in the opening months of 2016, the St Louis Fed index has been trending down or flat in sub-zero territory (see figure 1).

Figure 1. Chilled: Since the 2008 crisis, investors have been relaxed

MRI-chart-2

Source: Federal Reserve Bank of St Louis, Hermes as at 30 June 2017

But the big question for investors is how to reconcile these stress-free readings with the looming tightening of monetary conditions – or at least the phasing out of ‘unconventional’ central bank policies – and increasing global macroeconomic tensions.

For example, US politics have been distracted by international flashpoints, such as North Korea, or embroiled in the domestic dispute over the US President’s alleged Russian links. At the same time, the Trump administration has notably failed to progress key legislation through a theoretically compliant Senate and Congress.

Meanwhile, the world’s second-largest economy, China, has also disappointed somewhat in 2017: despite the unexpected resilience of the nation’s property market, nominal growth expectations remain conservative as policy-makers attempt to curb excessive credit and real-estate growth.

Against this disruptive global backdrop, financial market insouciance – as reflected in the sleepy St Louis Fed index – might seem a little misplaced, or complacent even.

Shattering news on complacency

While complacency might be, as author Vladmir Nabokov put it, “a state of mind that exists only in retrospective”, we think data can shed at least some light on the current condition.

Our Complacency Indicator, which is based on the premise that volatility has a history of long calm stretches punctuated by times of crisis, indicates that markets may be a little too relaxed (see figure 2).

It tracks two important components of volatility that we classify as ‘jumps’ and ‘long memory’: the former relates to the propensity of volatility to spike, while the latter suggests that deflation of the spikes is far slower than the initial jump.

We measure them by comparing volatility high points to the sum of the volatilities for the days constituting the jump. Using this technique, the higher the reading on the Complacency Indicator, the less complacent markets appear to be.

The indicator covers a period that includes three major market dislocations: the 1998 Long Term Capital Management/Russian default crisis, the so-called ‘dotcom’ collapse in 2001 and the three or four years from just before the GFC until 2011.

Figure 2 shows that all three events generated the classic long memory and jumps typical of market crises. Only the dotcom crash coincided with a high reading on the Complacency Indicator, showing that investors were anxious prior to the sell-off.

Figure 2. Complacency and crisis

MRI-chart-1

Source: Hermes, Bloomberg, CBOE as at 30 June 2017

Clearly, we are now in a period where risks threaten to make the market increasingly brittle but investors seem unfazed. Complacency, Nabokov concludes, “has to be shattered before being ascertained”. We hope that won’t be necessary.

Our latest analysis of the investment environment can be found in the current issue of Market Risk Insights. A summary of our expectations for the third quarter is as follows:

Volatility – A likely uptick from an environment characterised by very low volatility;

Correlation risk – A new correlation regime has not fully asserted itself, and investors should not rule out sharp movements in correlations;

Stretch risk – This is evident in both equity and credit markets, in terms of momentum and extreme valuations. In the face of greater leverage, as a result of lower volatility, we can only hope that any unwind will be orderly;

Liquidity risk – Liquidity concerns continue to be concentrated in bond markets, and investors should temper their appetite for yield with an awareness of how quickly the market could become paralysed by a wave of selling;

Event risk – The focus seems to have reverted from political and policy uncertainty to economic conditions, which for the time being convey modest growth. Look for market wobbles as quantitative tightening becomes more of a reality.

Share this post:
Eoin Murray Head of Investment Eoin is Head of Investment and a member of Hermes’ senior leadership team. Eoin also leads the Investment Office, which is responsible to clients for the investment teams’ consistent delivery of responsible, risk-adjusted performance and adherence to the processes which earned them their ‘kitemarks’. Eoin joined Hermes in January 2015 with over 20 years’ investment experience. Eoin joined from GSA Capital Partners, where he was a fund manager. Before this, he was Chief Investment Officer at Old Mutual from 2004 to 2008 and also held senior positions at Callanish Capital Partners LLP and Northern Trust Global Investments. He began his career as a graduate trainee at Manufacturers Hanover Trust (now JPMorgan Chase) and subsequently performed senior portfolio manager roles at Wells Fargo Nikko Investment Advisors (now BlackRock), PanAgora Asset Management and First Quadrant. Eoin earned an MA (Hons) in Economics and Law from the University of Edinburgh and an MBA from Warwick Business School. Eoin is a Freeman of the City of London, and a Liveryman of the Worshipful Company of Blacksmiths. He is a member of the Exmoor Search and Rescue team, a fully qualified Swift-water Rescue Technician and a Flood Water Incident Manager.
Read all articles by Eoin Murray

Find posts by author

  • Alex Knox, ACA
  • Amy Wilson
  • Andrew Jackson
  • Andrew Parry
  • Andrey Kuznetsov, CFA
  • Audra Stundziaite
  • Claire Gavini
  • Dr Michael Viehs
  • Elena Tedesco
  • Emeric Chenebaux
  • Eoin Murray
  • Gary Greenberg
  • Geir Lode
  • Geoffrey Wan, CFA
  • Hamish Galpin
  • Harriet Steel
  • Ilana Elbim
  • Jonathan Pines, CFA
  • Joseph Buckley
  • Kimberley Lewis
  • Louise Dudley
  • Mark Sherlock, CFA
  • Martin Todd
  • Maxime Le Floch, CFA
  • Michael Russell, CFA
  • Michael Vaughan
  • Mitch Reznick, CFA
  • Neil Williams
  • Nick Spooner
  • Nina Röhrbein
  • Patrick Marshall
  • Peter Hofbauer
  • Philip Nell
  • Saker Nusseibeh
  • Silvia Dall’Angelo
  • Tatiana Bosteels
  • Tim Crockford
  • Tim Goodman
  • Tommaso Mancuso
  • Yasmin Chowdhury

Find posts by category

  • risk

Press contacts