Traders welcome return of volatility

A sharp pull-back in US equity markets, sparked by chatter US President Donald Trump might face impeachment proceedings, didn’t alarm professional investors and analysts who said a correction of this sort had been long overdue.


Wall Street’s S&P500 shed 1.8 per cent on Wednesday, sparking an 0.8 per cent sell-off on the ASX.

Fast-moving developments kept US political issues front-of-mind during the session, with news emerging over the morning that the US Justice Department had appointed former FBI director Robert Mueller as special counsel to investigate possible collusion between Mr Trump’s 2016 campaign team and Russia.

But professional traders saw a silver lining, welcoming the up-tick in market volatility, which had been eerily low of late.

Last week, the Vix index – the so-called “fear gauge” for Wall Street that tracked implied volatility through options pricing in the S&P500 – traded near its lowest level for 25 years. Periods of low sharemarket volatility tended to concern professional traders, who worried a sense of complacency was infecting markets, leaving them overvalued and poorly equipped to deal with shocks.

With market volatility at historic lows, US investors had been “sleepwalking” into the sell off, ANZ analysts said on Thursday morning. The 1.8 per cent Wall Street drop – the largest in eight months – caused the Vix index to jump a huge 46 per cent.

“[Low volatility] can really lure investors into a false sense of security, thinking that all the risk is dissipated and it’s blue skies ahead,” said Perpetual’s head of multi-asset investment strategy Matt Sherwood.

“Low volatility can itself become a high-risk environment, because people can start overpaying for assets. This is a healthy reminder that, even in a growing climate, risk needs to be managed in portfolios, not only in terms of asset allocations but also stock selection, regional exposures, balance sheets and so on.

“Markets with low implied volatility are usually the best time to put protection on. When markets are rising, sometimes people say you don’t need it. They forget markets don’t always go up in a straight line.”

The fall reversed some of the gains made through several days of record closes on Wall Street, and so could be seen as a necessarily pull-back, Citi director of equities sales Karen Jorritsma said.

“If you look at what our US desk is saying, there’s no sense of panic coming out of them at this stage,” she said. “And globally, some of our clients are seeking value and coming back in, to add reflation exposure cheaply given the pull-back.

“It’s an opportunity to step back into a market that’s been overheated. Overall, the guys here are pretty relaxed. It’s too early to say if this’ll last.”

Mr Sherwood expected the sell-off to be short-lived, provided nothing emerged that improved the odds of an impeachment.

“The key for markets is the longevity of the crisis and how much serious political water President Trump takes on board,” he said. “The market downturn should be short term unless indictable evidence arises.

“If it does, the tax reform agenda will be out, the infrastructure spending agenda will be out and the regulation reducing growth agenda will go also. It will mean Washington’s sole focus will be on whether to impeach the President rather than focusing on growth-friendly reforms that markets can rally behind.”

BT Investment Management’s head of fixed interest Vimal Gor said: “The markets are continuing to question, with more urgency, the effectiveness of [Mr] Trump in getting through his manifesto items.”

Reflecting this heightened uncertainty, investors piled back into bonds, as yields on US Treasuries, which move inversely to the price, dropping as low 2.21 per cent overnight. Mr Gor labelled it “a material move”.

Meanwhile, futures contracts showed the market pricing on the odds of a US Fed interest rate hike had trended lower over the day, from 70 per cent to 60 per cent, highlighting the greater economic uncertainty. The US dollar index, which measured the US currency against those of its 10 largest trading partners, fell 0.8 per cent on Wednesday before recovering slightly by early Thursday. The Australian dollar rose in response.

This may impact local companies that earn in US dollars. Such companies have had a good run of late, but may be punished as investors reduce their US exposures off the back of the US dollar declines.

But the broader impact on locally listed companies at this stage looks limited.

“I think for us the situation in North Korea is also front of mind,” Ms Jorritsma said. “It’s never great for the ASX to see a Wall Street pull-back, but there are other issues for us as well.”

While remaining broadly comfortable with the sell-off, several investors pondered if the political headwinds caused by the US President could overwhelm the positive reflation trade his election unleashed.

“We’re four months into a four-year term,” Mr Sherwood said. “Normally at this time it’s a political honeymoon, approvals are sky high and things are getting done. But with [Mr] Trump there’s already mounting political risk. So it tells you the next three years and eight months are not going to be quiet.”

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