Steady markets—calm or complacent?

Brian Nick, Chief Investment Strategist, TIAA Investments

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February 10, 2017

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Quote of the week

“99.6%” — probability (via ESPN) of an Atlanta Falcons victory in Super Bowl LI with nine minutes remaining in the game and the Falcons ahead 28-16.

The Lead Story: What, me worry?

Has complacency seeped in to equity markets? On the surface, that seems to be the case. Since jumping 5% during the month after the presidential election, notching record highs along the way, the S&P 500 Index has risen at a markedly slower pace. Moreover, the index hasn’t closed up or down by more than 1% in a single session since December 7. 

The market’s relative inertia suggests that not enough risk has been priced in despite a number of potential hotspots, including political uncertainty at home and the upcoming elections in Europe, especially in France.

Brian Nick, Chief Investment Strategist, TIAA Investments

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Article Highlights

Moreover, trading indicators seem to confirm a lack of investor unease:

But looking under the market’s hood, we see a different story: rising anxiety. According to the SKEW Index, which estimates the probability of an abnormally large decline in the S&P 500, hedge funds and other institutional investors are paying more to protect against such a downdraft.

To illustrate, on January 20, the SKEW Index reached 146, up from 120 in mid-December. (By contrast, the index nearly hit 155 the day after the Brexit vote.) What does this mean? At 100, investors are ascribing little chance of a recession or “black-swan” event fueling a 25%-30% S&P 500 selloff. At 115, there’s a 6% chance. At 145, the risk rises to 12%. As of February 10, the SKEW index sits close to 130, implying that risks are not severe but remain elevated compared to normal levels.

So as a football referee might say, “Upon further review, investors do not appear to be irresponsibly complacent.”

Which brings us back to the Falcons. While their chances of winning were excellent that late in the game, assigning a 99.6% likelihood to any outcome in which human elements are involved is probably excessive. And, of course, the Super Bowl wasn’t the first time in recent memory that statistical models incorrectly ascribed near-certainty to the outcome of a binary event. (Hello, 2016 election polls!)

In other news: Late-week tax talk powers global equities

President Trump’s February 9 promise to enact “phenomenal” corporate tax reform propelled equity markets. After meandering through mid-week, the S&P 500 Index rallied to fresh record highs, finishing with a gain of about 0.9% for the week. Financial stocks were the main beneficiary of the news, advancing 1.4% on February 9 alone. Europe’s STOXX 600 Index followed the U.S. higher, returning 0.9% (in local terms) for the week.

While equity investors were upbeat, fixed-income markets expressed caution amid political risks in Europe and reduced expectations for new fiscal stimulus from the Trump administration this year. March’s general election in the Netherlands may test the strength of European populism. Also looming: the possibility that a far-right party could win the French presidency, potentially leading to the country’s withdrawal from the Eurozone. In our view, such an anti-euro government outcome is not likely.  Against this uncertain backdrop, demand rose for U.S. Treasuries, sending the yield on the bellwether 10-year note down to 2.34% on February 8 before closing the week at 2.41%. (Yield and price move in opposite directions.)

Current updates to the week’s market results are available here

Below the fold: Emerging-market equities off to a quick start

After years of heavy outflows and poor performance, emerging-market (EM) equities attracted investor interest in 2016, a trend that has continued this year. According to MSCI indexes for the year to date through February 9, EM stocks have advanced 7.39% and 5.14% in U.S. dollar and local currency terms, respectively, outpacing their international developed-market counterparts (+3.0% and +0.99%). In our view, EM equities have further scope to outperform, as both their earnings and valuations have only recently bottomed.

Highlights from the key “BRIC” (Brazil, Russia, India, and China) markets include: 

Back page: Does the Patriots win augur a down year for U.S. stocks?

In 40 of the first 50 Super Bowls, a victory by an original NFL team (e.g.,the Steelers) has led to an up year for the Dow Jones Industrial Average. In contrast, a win by an AFL descendant has presaged a market decline. But please take this spurious forecasting model with more than a few grains of salt. Correlations do not equal causations. Despite the Patriots comeback, we still expect a modest gain for the S&P 500 this year.

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