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Quarterly Risk Review
Insight 3Q14

Melissa Brown
Senior Director, Applied Research

Markets Tossed, but Risk Remained Steady-As-She-Goes

While markets wobbled in the third quarter, many risk forecasts–especially medium-horizon–continued the decline that started in late 2011. For US largecap stocks, the level of risk was lower than all but a handful of month-end values since the model’s inception in 1982. The Canadian market, as measured by the TSX Composite, remained the lowest risk of the major benchmarks we track, while Japan’s 4.2 percentage point decrease in mediumhorizon risk was by far the biggest. The broadest benchmarks saw medium-horizon risk fall by one percentage point during the quarter, while short-horizon forecasts rose a bit.


 

Quarterly Risk Review
Insight 3Q14

Melissa Brown
Senior Director, Applied Research

The Calm Before The...?

  • Investors Show Little Fear, The Wall Street Journal, May 23
  • It’s Easy to Forget About Risk in a Stable Market, The New York Times, June 2
  • Fed Officials Growing Wary of Market Complacency, The Wall Street Journal, June 3
  • Wall Street’s New Normal - Quiet, The Wall Street Journal, June 5
  • Wall Street’s ‘Fear Gauge’ Hits 7-year Low, Financial Times, June 8

This report on the decrease in risk during the second quarter, and the extremely low levels of risk in many markets, is unlikely to surprise to anyone. The burning question is, what, if anything, does it portend?


 

Quarterly Risk Review
Insight 1Q14

Melissa Brown
Senior Director, Applied Research

What Was That?

Call it a speed bump. After a strong 2013, most markets abruptly hit the brakes in January. Concerns over both the impact of Fed tapering and high valuations hit many markets hard, especially Japan, which had been a 2013 market leader. But the effect was short-lived. Investors looked past their immediate concerns to better corporate results in the US, and to Europe returning to a path of growth. Certain emerging markets – such as the so-called “fragile five” – also showed signs of recovering. These markets were hard hit by the initial tapering announcement late last spring, but fared quite well in the first quarter, as their governments worked to clean up some of the concerns about their local economies. Overall, markets settled down and made up the ground they lost in January—in many cases ending the quarter higher than where they started, although Japan continued to struggle throughout the quarter as a result of domestic issues. So as the quarter drew to a close, it appeared that investor anguish over central bank and regulatory actions – the major drivers of equity returns over the past few years – had faded. Even geo-political events, like the turmoil in the Ukraine, had little bearing outside of Ukraine and Russia – at least as far as the financial markets were concerned.


 

Quarterly Risk Review
Insight 4Q13

Melissa Brown
Senior Director, Applied Research

2013 Year in Review

As Frank Sinatra once crooned, it was a very good year...

Most markets posted substantial returns in 2013, with the US and Japan the strongest of the strong. In fact, Japan had the highest return of the markets we track, gaining more than 45%. Despite (or perhaps because of) looming action by the US Fed to taper off its bond-buying, US markets surged in the fourth quarter, with the most economically sensitive sectors leading the way. The market, it appears, views the Fed action as an indication that the US economy is on the upswing. Returns in developed markets were substantially higher than those in emerging markets. The FTSE Developed Index gained almost 25%, whereas the FTSE Emerging Index was up less than 5%, with most of the difference occurring in the first half of the year.


 

Quarterly Risk Review
Insight 3Q13

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

Tales of the Taper

It was back in 2011 that James Bullard, President and CEO of the Federal Reserve Bank of St.Louis, was perhaps first to use the term “taper” in referring to a gradual reduction of quantitative easing. In May of 2013, it was Federal Reserve Chairman Ben Bernanke who spoke of “tapering”, and the word has never been the same since. The term, once used mainly in the context of candles and trouser legs, weighed most heavily on investors’ minds this quarter, as global markets continued to react to even the slightest mutterings of the US Federal Reserve. Yet, while the start of the quarter saw markets fearful of an imminent reduction in quantitative easing, by September the risk trade was back on and most markets around the world had happily recovered ground lost in June (and then some).


 

Quarterly Risk Review
Insight 2Q13

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

Uneasy Riders

Murmurs by the US Federal Reserve of a possible end to quantitative easing in 2014. A possible retreat from “Abenomics” stimulus in Japan. Actions by China to rein in its shadow banking system. The net result was an increase in volatility in the second quarter, though levels remained relatively low compared with recent historical peaks. The effects were strongest in China and Japan, though most of Asia and Australia, too, reacted negatively. Only a year ago it was Europe that was the focal point of global concerns. Those concerns may now be shifting to the East.

While we have observed historically low levels of volatility in all the major markets for much of this year, many of the underlying macro issues that were key drivers of market volatility in recent years have hardly vanished. We have been reminded of this over the last month as volatility again began to climb, driven predominantly by macro and, more specifically, “government policy” news. The impact of the revived concerns was bigger from the perspective of our short-horizon models, where risk for major indices increased between 3% (for FTSE North America, in USD) and 11.3% (for FTSE Japan, in JPY) from the end of the first quarter of 2013 to the end of the second quarter.


 

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Quarterly Risk Review
Insight 1Q13

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

What, Me Worry?

The US “sequestration.” Panic in Cyprus. Weak job growth in both Europe and the US. None of it seemed to have much of an impact on risk in the first quarter. Markets were generally strong and predicted risk largely continued the decline that started a year ago. For instance: short-horizon volatility forecasts for largeand small-cap US stocks and for the FTSE North America index fell more than two percentage points, while several benchmarks in Europe saw similar-magnitude declines at the medium horizon. Inevitably, of course, some refused to get with the program.

Forecasts for China, Japan and Australia bucked the trend, as risk increased during the quarter, especially at the short horizon. China’s forecast risk (in USD for the CSI 300) now exceeds that of the Euro-Crisis countries (in EUR), and FTSE Japan (in JPY) is now one of the riskiest benchmarks we cover; a year ago it was one of the least risky.

All of the benchmarks we track had far lower risk forecasts at the end of the first quarter of 2013 than they did at the end of the same quarter in 2012, with the exception of Japan, where short-horizon risk ended 1Q 2013 more than six percentage points higher than a year earlier.


 

Quarterly Risk Review
Insight 4Q12

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

2012: In Like A Lion, Out Like A Lamb?

Risk continued to ease in the fourth quarter. Following on the heels of a sharp drop in the third quarter of 2012, fundamental model predicted risk, both medium- and short-horizon, continued their downward march during the fourth quarter for most benchmarks we track. Most notable was the continued decrease in risk for European benchmarks. Medium-horizon risk for the Euro Crisis1 countries fell nine percentage points, with short horizon risk falling just a bit more. However, risk for this set of countries remained above that of other benchmarks around the world and the percentage-point decline versus a year ago was no larger than for most other benchmarks. We are comfortable that current levels of risk around the world can be sustained and believe that if risk stays low, more investors will be enticed back into the market...and the market's rally should continue.


A new feature of the Insight reports is the ability to go directly to a section, figure or table by clicking on the relevant line on the “What’s Inside” page, page 4.


 

Quarterly Risk Review
Insight 3Q12

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

Whistling Dixie…or Whistling Past the Graveyard?

It's been said that the market climbs a wall of worry. Most markets posted strong gains in the third quarter of 2012. And if Axioma's risk models can be seen as a proxy for "worry", the market not so much climbed a wall as coasted downhill in the latest quarter. The VIX, at its lowest level since 2007, also suggests a relative lack of concern. Yet the data seem peculiarly at odds with recent alarming headlines.

There are several possible explanations for the sharp drop in risk, despite continued concerns about Europe, the US "fiscal cliff" potential, slowing growth in China, etc. For example, all of these concerns could already be baked into stock prices and hence are therefore no longer driving volatility. On the other hand, the extreme uncertainty may have simply paralyzed investors and therefore volatility has declined (our special section on liquidity shows average daily volume has declined, especially as a percent of market cap). Or, more ominously, this could be the calm before the storm.

Quarterly Risk Review
Insight 2Q12

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

Concerns over European markets and the risk of global contagion surged in the second quarter, resulting in negative returns in many markets—this coming on the heels of a relatively optimistic first quarter. Despite these renewed concerns, medium-horizon predicted risk declined by 1-2% for most of the benchmarks we track. In most cases, however, risk remained higher than it was a year ago, especially for the FTSE Eurobloc countries and most notably for the PIIGS (Portugal, Italy, Ireland, Greece and Spain). This edition of Axioma Insight includes a special section on risk, focusing on key European countries. The exception to increased risk versus a year ago was Japan. At the end of the second quarter of 2011 the aftermath of the earthquake and tsunami still weighed heavily on predicted risk. As those concerns have abated, Japan’s risk is now substantially lower than a year earlier.


 

Quarterly Risk Review
Insight 1Q12

Melissa Brown
Senior Director, Applied Research

Scott Hamilton
Director, Applied Research

Markets across the globe were strong in the first quarter. As global economic concerns seemed to ease, downward trends in risk for the period mirrored the markets’ strength. Compared with the end of the fourth quarter, risk fell substantially for most of the benchmarks we track, although risk remained higher in most cases than it was a year ago. Risk forecasts for the FTSE Eurobloc fell the most from the end of the fourth quarter, in both USD and EUR terms. However, Eurobloc-related benchmarks continued to have the highest risk forecasts. Unlike other global markets, China saw only a small decrease in risk, although risk at the end of the quarter was lower than a year ago. The only other benchmark to see a decline in risk on a year-ago basis was Japan, reflecting the earthquake and tsunami that occurred in the first quarter of 2011.


 

Insight 4Q11

Melissa Brown
Senior Director, Marketing

Scott Hamilton
Director, Client Services

For this issue we are tracking a few additional benchmarks and benchmark derivatives. In addition, for many regional benchmarks we are calculating risk in both the local currency and US dollars. Due to currency effects, these estimates can be quite different, as Table 1 illustrates. Most benchmarks saw their risk increase since the end of the third quarter, and risk estimates were substantially higher across the board than they were a year ago. For many of the benchmarks we track, however, risk peaked in October or November, and declined by the end of the year.

PIIGS, FTSE Europe, FTSE Eurobloc and the SP-ASX 200 denominated in USD showed the highest risk, joined by the Russell 2000. Among the European indexes, PIIGS and FTSE Eurobloc also appeared quite risky even in their home currency, whereas the non-Eurobloc indexes exhibited some of the lowest risk when denominated in EUR. Risk estimates in USD for many of these developed markets are also substantially higher than predicted risk in the same currency for the FTSE Emerging index, indicating the ongoing fragility of the markets. The SP-ASX 200 denominated in AUD, with one of the lowest risk estimates, stood in sharp contrast to the high risk of the same stocks in USD.

The death of Kim Jong Il in December, although big news in Asia and globally, did not seem to have any meaningful impact on risk forecasts for the Asia Pacific region, Japan or in emerging markets.


 

Melissa Brown
Senior Director, Marketing

Scott Hamilton
Director, Client Services

Quarter-end predicted risk for many benchmarks around the world was higher, in most cases substantially higher, than it was at the end of the prior quarter (Table 1). The one exception was Japan, which was likely still suffering the effects of the earthquake and tsunami at the end of July. Japan has now moved from above-average risk relative to other major markets last quarter to below-average risk. Not surprisingly the Euro block forecast risk is currently the highest of the major markets.

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