After a cataclysmic start to the year (after which market strategists then capriciously reduced their 2016 forecasts), markets have since enjoyed a low-risk period of prices rising to all-time highs. With 3rd quarter now behind us, it is worth asking what might be in store for this final quarter of the year. We argue that the most recent period of suppressed volatility is a record for this recovery, and the extended smooth-sailing we've experienced can not simply remain undisturbed- from here on out. Three months is a very lengthy period for risk trading (>60 trading days). And the checkered heat-map below of risk days shows it is unusual to remain risk-free, for a period that enduring through year-end. At some point, acute torture will be felt.
An example from just Q3-end is that it has been 12 days since we last saw a market drop of more than 1%. This is much higher than the median streak of 8 days, between daily drops of this severity (going back a decade, or prior to the global financial crisis). And the 90th percentile for this statistic is even higher at 21 days, or put differently less than 10% of streaks are beyond 21 days. It would be increasingly unlikely that we would get to that point (jointly with a 6-day streak in the other direction of no >1% market rises), given the notable risks before us.
What are these myriad risks? A falling GDP growth rate versus what we've seen earlier this year. Record high markets and price multiples that now see asymmetric risks to the downside. Federal Reserve's Janet Yellen insisting that rates will rise soon. Election uncertainty that is not currently priced-in. And concerns about a settlement with Deutsche Bank that remain unresolved. Of course there are drastic known unknowns, such as:
And while obviously not forecasting this, it is always worth recollecting that outright global black swan events that can always creep-up once a cycle (proud to note that connoisseur Nassim Taleb is one of the celebrities following this blog). In any event, one can appreciate that the untangling of a bubbled-up market never ends well.
We also see on the left chart above a different risk perspective. That in any of the calendar years for the past decade, no year had >5 months when there was no 1% or worse drops. These risk-free months are color-coded white (on an aside the record high for these drop months was 13 days - exactly 8 years ago during October). So far in 2016 we've seen 3 such exclusively risk-free months, therefore we would be setting an unusual record to see the remaining 3 months all be risk-free.
In the same year of 2006, and also 2007 when the last equity market peaked, we also never saw >3 months when there was no 1% or better rises. These muted months are also color-coded white (but now using the right chart above). So far in 2016 we've seen only 1 such month, and so it would be a record if we saw the remaining 3 months all be not risk-free. We note this because volatile markets see exaggerated moves in both directions, not simply muted in the up direction. The above charts evidence that this reversal of a streak, in market muted days and months, is expected to be the case in Q4. Continue to consider risk, and remain prudent.
An example from just Q3-end is that it has been 12 days since we last saw a market drop of more than 1%. This is much higher than the median streak of 8 days, between daily drops of this severity (going back a decade, or prior to the global financial crisis). And the 90th percentile for this statistic is even higher at 21 days, or put differently less than 10% of streaks are beyond 21 days. It would be increasingly unlikely that we would get to that point (jointly with a 6-day streak in the other direction of no >1% market rises), given the notable risks before us.
What are these myriad risks? A falling GDP growth rate versus what we've seen earlier this year. Record high markets and price multiples that now see asymmetric risks to the downside. Federal Reserve's Janet Yellen insisting that rates will rise soon. Election uncertainty that is not currently priced-in. And concerns about a settlement with Deutsche Bank that remain unresolved. Of course there are drastic known unknowns, such as:
- a large terrorist attack in a Western nation
- or an unforeseen natural disaster
- or a widening of the civil unrest against the police if Trump leads in polls
- or enormous fraud in a less paid-attention-to section of the economy
- or a sudden reversal in market sector
And while obviously not forecasting this, it is always worth recollecting that outright global black swan events that can always creep-up once a cycle (proud to note that connoisseur Nassim Taleb is one of the celebrities following this blog). In any event, one can appreciate that the untangling of a bubbled-up market never ends well.
We also see on the left chart above a different risk perspective. That in any of the calendar years for the past decade, no year had >5 months when there was no 1% or worse drops. These risk-free months are color-coded white (on an aside the record high for these drop months was 13 days - exactly 8 years ago during October). So far in 2016 we've seen 3 such exclusively risk-free months, therefore we would be setting an unusual record to see the remaining 3 months all be risk-free.
In the same year of 2006, and also 2007 when the last equity market peaked, we also never saw >3 months when there was no 1% or better rises. These muted months are also color-coded white (but now using the right chart above). So far in 2016 we've seen only 1 such month, and so it would be a record if we saw the remaining 3 months all be not risk-free. We note this because volatile markets see exaggerated moves in both directions, not simply muted in the up direction. The above charts evidence that this reversal of a streak, in market muted days and months, is expected to be the case in Q4. Continue to consider risk, and remain prudent.
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