Photo: NOAA. Source: Wikimedia
That’s what I thought when I looked at last month’s returns. Equity markets around the world were down around 5% last month, led by economic stalwarts like Johnson & Johnson and Samsung Electronics. Growth-oriented companies, like Amazon and Microsoft, still keep chugging along. But the market’s unbroken string of monthly advances – with barely a pause to admire the scenery – ended in February.
A series of scary stories has spooked market participants. First was a concern about rising interest rates, supported by a change in leadership at the Fed. Chairman Powell is taking the reins from Chair Yellen when the global economy is experiencing a synchronized global expansion, unemployment is near a record low level, and interest rates are still accommodative: the Fed Funds rate is lower than the core inflation rate. The market expects higher rates, the question has been how high, and how fast the Fed will move. Powell indicated that rates a year from now could easily be 1% higher than they are now.
Second came a flash-crash in a set of Exchange Traded Products that are tied to a stock market volatility index, the VIX. Volatility is the raw material that market makers use to construct options, and portfolio managers can employ options in various ways. One of the most common is selling options to enhance income. With rates so low for so long, many fund managers engineered higher yields by selling puts and calls on the market. This put downward pressure on volatility. But with rates rising, there’s less need to sell options and the VIX started rising. We saw what looked like a short-squeeze in volatility – which hit 50, a panic level – and some volatility-related ETFs collapsed and liquidated. This had chilling effect on investors.
Volatility Index. Source: Bloomberg
Finally, we saw the Trump Administration make good on its campaign promise to get tough on trade. Yesterday President Trump announced that the US would impose a 25% tariff on imported steel and a 10% duty on aluminum, citing national security concerns. This comes just as US, Canadian, and Mexican negotiators are working to update the North American Free Trade Agreement, and the Administration is blocking mergers with Chinese companies in semiconductors and money transfers. The threat of retaliation by our trade partners is a real concern. A spiral of tit-for-tat protectionist measures could undermine global growth.
Risk is measurable. When you roll the dice or play poker, you can calculate the odds. Uncertainty is indeterminate. What are the odds of a tsunami flooding a nuclear power plant in Japan, or quantum computing making our current security software obsolete? No one knows. The future has a series of forks in the road that lead to unpredictable destinations. That’s what risk management is all about.
We don’t know the future. Although the heart may long for clarity and stability, our curious spirit finds uncertainty infinitely fascinating. It’s important to find the right balance.
Douglas R. Tengdin, CFA