The start of this year witnessed a rapid and significant decline in equity prices and a sharp increase in implied volatility. But since February, markets have recovered strongly. This has reminded investors of the current paradoxical environment of low volatility and strong asset returns co-existing with troubled and uncertain economic conditions. However, there are aspects of the market risk environment that
While the timing of interest rate increases is uncertain, it is at least expected in the US, and while emerging markets have demonstrated elevated persistence and valuation risk for some time, the recent sharp reversal in their fortunes has amplified these risks. At the same time, there are continuing themes of elevated geopolitical uncertainty, the nearing UK referendum on remaining in the European Union, and a migrant crisis that is becoming increasingly politically challenging. These tensions highlight material and obvious event risks that continue to drive market sentiment.
Firstly, while volatility is currently low, it has been subject to very rapid variation through time. Secondly, the event risks we describe are material and markets have demonstrated little initial ability to absorb shocks. Speed of decision making is key where activities are focused on exploiting short-term opportunities and attention must be paid to the investment horizon and the potential wide variation of market movements.
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