Is Risk Really as Low as You Think?

Traders Magazine Online News, March 6, 2017

Melissa Brown

The media has seized on the seeming paradox of high market uncertainty accompanied by unusually low equity market volatility. For example:

• “What VIX Is Really Telling Markets,” The Wall Street Journal, Feb. 14, 2017.

• “What everyone gets wrong about the ‘fear index,’” Yahoo Finance, Feb. 7, 2017.

• “Alternative Facts for Trump and the Stock Market: Divergence of stocks and uncertainty could be attributed to inability to assess, or it could be ‘good’ uncertainty,” The Wall Street Journal, January 24, 2017.

The uncertainty has many potential sources. What will be the impact of Trump’s policies? Will we see more populist uprisings? Will central banks reverse course?

Forecasts from Axioma’s risk models concur—risk seems unusually low and, in fact, has fallen fairly steadily over the last 12 months, with just a few hiccups related to the Brexit vote and the US election.

However, to Mangle a Metaphor, the Falling Tide of Market Risk Has not Dropped All Boats.

Since the US election, total risk for the FTSE Developed Index fell almost 300 basis points, and risk is down more than 10 percentage points since the near-term high reached in February 2016. While the latest reading has not breached the prior low (risk at the end of January was just under 10%, slightly above the low of 8.6% reached in July 2014), it does fall in the bottom decile of month-end values since 2000. In addition, there has been no other time in the history of the model in which risk had recently fallen to a relatively low level and at the same time country risk rose.  In 20042005, however, overall risk was quite low yet currency risk was rising.

And broad market indices, such as FTSE Developed, are not alone. A number of individual markets are also experiencing similarly low levels of risk, which fell throughout 2016 and into this year (Figure 2). The wellknown and widely cited VIX index is also unusually low these days, as is the European-based VSTOXX and Japan’s Nikkei Volatility Index JNIV. However, one of the advantages of using a risk model is that investors can identify the sources of risk, which may also help guide the management of portfolio risk.

In the rest of this paper, we will drill down into Axioma’s risk models, with two goals: 1) to identify reasons that risk is so low, and 2) to identify sources of risk that have bucked the downward trend. Note that our analysis is based on results from Axioma’s Worldwide short-horizon fundamental model.

For more information on related topics, visit the following channels:

• Insights/Viewpoints