Lull after April sell-off may spell further volatility in H2 2014
With little movement, opportunities would seem limited in the market but with omnipresent anomalies the lull in activity feels uncanny and could be a precursor of volatility
The environment of low return, low volume and low volatility will likely persist, with periodical volatility flares.
Doldrums have returned, after a dramatic sell off in small caps and momentum stocks in April and May. But market anomalies are omnipresent. Peripheral European bonds have fared well, with Irish ten-year yielding lower than US treasury. Overseas market sentiment is as euphoric as it was just before Black Monday in 1987 and before the global crisis starting in October 2007. Small caps valuation stays extremely rich, similar to where it was just before the ‘97 Asian Crisis and the internet bubble burst in March 2000. Meanwhile, the volatility of the RMB is higher than that of Euro, and Argentina is the best performing market after the sudden peso devaluation in February. And iron ore keeps making new lows. Amid all these incongruities, the market’s lull feels uncanny.
Focus Chart 1: Market returns likely to be subdued in 2H, with intermittent volatility flares.
Many are complacent, but even more are boldly calling for a return of volatility. Both positions are not without merits, but neither will be entirely satisfied. Our market path forecast model, with a solid track record, is suggesting a period of low, but subdued returns ahead (Focus Chart 1). Volatility will flare up soon, but it is also likely to be transient. Central banks are now the biggest buyers and holders of government bonds. With bond yields firmly anchored, volatility spillover from smaller asset classes will likely to be fleeting, much like a small rock skipping through a big pond.
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