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Volatility Returns

Jack Turner, Research Analyst

This week we look at the return of volatility to the market, three pieces of news coming from the UK, US and Germany, and an update on two portfolio actions.

Volatility Returns

In 2017, the S&P 500 moved by 1% or more just eight times in the whole year. But this level of volatility is very low –you have to look back to the early 1960s to see a similar year. As the end of January 2018 dawned, however, volatility returned to markets with movements of 1% or more taking place more frequently. But on average these movements are only taking place a little over once a week –the long term average for the market. So why are investors surprised?


NEWS

UK UPDATE
In its quarterly inflation report, the Bank of England stated that rates would need to rise "earlier" than previously thought and by a "somewhat greater extent" than their last review in November in order to be able to offset the effects of stronger global growth on UK inflation. The Bank also noted that wage growth was starting to pick up, with the annualised rate of growth of pay rising to around 3% in the second half of 2017, which is expected to grow faster in 2018. The Bank also, however, warned that the UK’s enthusiasm for borrowing could become unsustainable, particularly as interest rates rise.

GERMANY UPDATE
Angela Merkel has agreed to a grand coalition deal with the SPD, ceding three major portfolios of finance, foreign affairs and labour of Germany’s top five ministerial posts. This leaves the Merkel’s CDU with Economy Ministry and Bavaria’s CSU with the Interior Ministry. The CSU has a tougher line on immigration than the CDU. However, the deal has yet to be put to the vote of SPD members and there are some activists in the party pushing hard to stop the deal, even reportedly turning to the Labour grassroots’ movement, Momentum, for advice on how to derail the coalition.

US UPDATE
The US trade deficit grew 12.1% to its highest level since October 2008 after a year of Donald Trump sitting in office, suggesting that the President was making little headway in his promise to rewrite the US’s trading relationship with the world. The trade deficit number came in at US$53.1bn in December 2017. It followed a downward revision of a $50.4bn gap in November and compared to market expectations of a US$52bn shortfall. Recent tax cuts are only likely to increase the deficit still further, despite the weaker US Dollar, given the full employment levels mean that the economy is already at capacity and so any increase in demand can only likely be satisfied with imports.


PORTFOLIO ACTIONS
The team took advantage of market movements to increase their holdings in the FTSE 100 at a discount to levels seen in the last quarter. While the index is prone to changing investment sentiment versus the value of Sterling, the global equity index should do well given the strength and growth prospects of the global economy. The move saw a 1% increase to our investments across all risk profiles.

In addition, we have added positions in 5-year US Treasuries. These offer tail risk protection against a potential downturn in stockmarkets given the current run is the third longest in US equity market history. While the length of the cycle is not, in itself, a concern, there is the view that the cycle could run out of legs given that markets typically dip some six to 12 months before the economy runs out of steam. The US Treasuries also offer a good yield and low duration.


THREE ANNOUNCEMENTS DUE THIS WEEK
14 Feb –US Inflation Rate (Jan) // 15 Jan –Eurozone Balance of Trade (Dec) // 16 Feb –UK Retail Sales (Jan)

SOURCES: BANK OF ENGLAND; BLOOMBERG; REUTERS; 7IM

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