Market Risk Monitor – October 2018

Edward J. Fishwick |30-Oct-2018

The latest issue of the Market Risk Monitor assesses how the risk environment has changed over the third quarter of 2018 and seeks to put the recent spike in volatility into perspective.

Capital at risk: all financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed.

Download the report

The opinions expressed are as of October 2018 and are subject to change at any time due to changes in market or economic conditions. The above descriptions are meant to be illustrative. There is no guarantee that any forecasts made will come to pass.

Need for vigilance

While the change in risk measures reported was marginal over the quarter, the recent spike in volatility in an environment of rising interest rates warrants detailed attention across the elements of risk.

Market Risk Monitor

Ed Fishwick and Tara Sharma from the Risk & Quantitative Analysis Team discuss the current risk environment and explore whether the recent volatility suggests a major change in the risk environment.

At this stage, it is too early to tell whether the recent uptick in volatility is a temporary spike, similar to the previous episodes we have experienced, or the start of a prolonged period of risk aversion. The BlackRock Investment Institute’s central scenario is still one of above-trend economic growth, but we also note the decisive scaling back of monetary policy support and event risk in the form of trade tensions and China-US tensions. Moreover, we see stretched valuations in certain pockets of the market. Taken together, these developments suggest a less straightforward risk environment to navigate.

Volatility, the primary metric of market risk, declined further over the quarter, with the VIX and MOVE indices averaging respectively 13 and 50 basis points over the last three months. These readings compare to long-term averages of 17.3 for the VIX index and 90bps for the MOVE index respectively. Volatility across different sections of the market was also subdued with the monthly, realised cross-sectional volatility in the S&P 500 ending the quarter at 5.65 compared to a monthly historical average of above 7.

However, if we look beneath the surface, it is possible to capture some of the tension between low observed market volatility and the potential of a sudden increase in both implied and realised volatility. One of those metrics is the SKEW index, which measures the perceived asymmetry in the returns to the S&P 500. Data up to quarter end show a marked move into negative territory compared to the long-term distribution, thus implying a higher probability of losses.

Implied skew

The skew in S&P 500 option contracts since January 1990

Implied skew

Index data provided for illustrative purposes only. Indices are unmanaged and it is not possible to invest directly in an index. Source: Chart by BlackRock using data from Bloomberg – data in USD as at end of September 2018.

In addition, we see growing valuation risk at the US and the UK overall market level, coupled with increased persistence risk, suggesting increased vulnerability to rising interest rates.

While it remains to be seen whether the most recent spike will deviate from the recent trend of short-lived bouts of risk aversion, we believe that risk has increased, meaning close monitoring of our elements of risk will be more crucial than ever.

Download the report