From an investment perspective we tend to think about volatility as the variation in price returns over a given period, and the spread of returns within asset classes.
But we can also think about volatility in terms of uncertainty and changing dynamics in the macro and business landscape that companies and consumers face.
Asset market volatility has increased in 2022; first as investors wrestled with the more hawkish tone emanating from developed market central banks and, more recently, in reaction to the shock and geopolitical fractures caused by the conflict in Ukraine. Higher volatility means more asset prices are overreacting as companies, consumers, and investors acclimatise to a different macro and geopolitical landscape. That brings opportunities that, as investors, it is our job to identify.
Gillian Tett’s fascinating FT article on March 24 noted that, surprisingly, after an initial upwards spike, periods of war often do not lead to subsequent periods of elevated volatility. The overreaction eventually (sometimes quickly) corrects. The suggested explanation for falling volatility now is that government spending priorities create more earnings certainty for key sectors of the market. This presupposes that higher recent volatility is solely a reaction to the Ukraine conflict.
However, we view it as another significant staging post in a market transition that began pre-pandemic and accelerated as markets wrestled with the implications of significant changes in macro policy making, geopolitics, corporate behaviour, and societal attitudes.
From a broad range of perspectives, we are witnessing shifting dynamics; from the post global financial crisis environment of monetary expansion aligned with fiscal austerity, to the pandemic world of fiscal expansion and strong monetary accommodation, to one of fiscal expansion and less accommodative monetary policy. Politics are fracturing away from globalisation towards regionalisation.
Corporates, as a function of that, are tilting from maximising efficiency via the Dupont/'just in time' model towards an emphasis on resilience/'just in case' supply-chain management.
They are seeking more certainty in an uncertain world. Lastly, the investment world itself is driving towards stakeholder capitalism as the green agenda and complex social and governance issues become central in clients’ focus, reflecting wider societal change. These are significant adjustments to navigate, and the process will not be smooth.
Over the past decade, in response to the low-growth and deflationary backdrop, the combination of ultra-low interest rates and central bank bond purchases saw developed market central bank policy converge to become ultra-accommodative across the board. Investors became conditioned to an implicit central bank ‘put’ to protect them from falling markets.
Persistent below-target inflation fostered confidence in that trend, allowing investors to take on more risk in areas of the market that were beneficiaries – long-duration assets such as fixed income, the quality/stable growers within the equity market and, most spectacularly, the technology sector.
But central bankers are increasingly indicating that the monetary safety net is being removed. Policy reactions to the pandemic, political reactions to the war in Ukraine, and the exacerbation of supply-chain tensions have created a more inflationary backdrop, as evidenced by the highest inflation prints in 30 years. To varying degrees developed market central banks are taking a more hawkish stance. This less co-ordinated global monetary policy backdrop is likely to mean greater bond and currency moves.