Turbulence
has many Investor Fear for the Worst
The volatility across
markets is likely to last until at least next few hours when the Bank of Japan
and the Federal Reserve give their latest decision on interest rates. While
bonds and equities have both been hit since last few days, the pain in parts of
the market points to the wide range of concerns troubling investors.
Japanese long bonds
This year’s historic debt
rally is faltering, but the real pain has been in long bonds. And the chief
source of anguish is Japan, where there is speculation the Bank of Japan may
pull back from buying long bonds in an effort to shield banks that historically
have relied on a steep yield curve for profits.
The yield on the 30-year
JGB has climbed from a low of 0.047 per cent in early July to 0.57 per cent,
and a chunk of it has come in the past few days. That trimmed gains for the
bonds to a mere 22 per cent this year from the even giddier 35 per cent at the
peak of their rally.
And no one so far, is
buying the dip. Market consensus seems that
may not see global long ends gain traction until we get the BOJ and the Fed
meeting hours after it, is behind us.
Energy shares
A sinking oil price had a
starring role in the market turmoil at the start of the year. Its current slide
is central to the much more modest squall this week. Shares of US energy
producers have been among the hardest hit. The energy sector’s 5.4 per cent
drop since Friday is more than double that of the S&P 500. US crude has
tumbled 6.7 per cent.
Exploration and production
groups have sustained steep drops, as investors judge them as being especially
sensitive to swings in oil. Marathon Oil and Murphy Oil, for example, have both
had double digit declines since last week.
Just as anxiety has flared
over whether central banks will sustain their monetary largesse, so has fear
that the outlook for the oil price is deteriorating. Those worries were
amplified on Tuesday after the International Energy Agency forecast the global
oil glut may bleed well into 2017.
Periphery bonds
Although two sharp daily
declines in the S&P 500 since last couple of days have grabbed attention,
investors’ current disquiet began in the debt markets after the European
Central Bank failed late last week to announce an extension of its bond buying
programme.
Some of the Eurozone’s
weakest economies, including Italy, Spain and Portugal, are still feeling the
effects. The extra yield investors demand to hold Italy’s benchmark 10-year
bonds instead of German debt has jumped from 1.17 percentage points last week
to 1.27.
Spain has seen the spread
between its bonds and German equivalents rise 13 basis points to 1.04 per cent,
while the spread in Portugal, where investors are growing increasingly worried
about the extent of a bank bailout required, has increased by over 20 basis
points.
Market participants feel
that the ECB to ultimately extend its stimulus
measures to staunch a deeper sell off.
US real estate
American real estate shares
shed more light on what is gnawing away at investors. The sector has dropped
5.2 per cent since late last week. Yes, it has been shunned because the shares’
steady dividend streams may be less attractive in a world in which interest
rates are rising.
But there is also cyclical
component to their under performance, the summer saw the first drop in annual
home sales since last November, raising fears among some economists that the
rebound in home sales is running out of steam.
Risk parity funds
Risk parity funds have
enjoyed a bounce this year after a torrid 2015, but have been hit badly in the
latest turbulence.
The strategy involves
investing in a broad pool of diversified asset classes according to their
mathematical volatility, the idea being that they mostly move in different
directions, but over time, should provide healthy returns. But when both bond
and stock markets fall the pain can be severe.
The Salient Risk Parity
Index had gained over 20 per cent this year until early September, thanks to
central bank policies buoying bonds and equities, but has traded water since
July, and since Thursday has fallen nearly 5 per cent.
Some analysts fear the
funds will pare their exposure to keep their riskiness constant, leading to a
feedback loop as their automated selling weighs further on markets in the
coming weeks.
_ Farzan Ghadially
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