No need to argue that the economic backdrop looks to be improving globally. The trend started before the U.S. elections in November 2016 and has accelerated since then. The question today is whether we are at the beginning of a sustainable transition out of the “secular stagnation”1 we have experienced over the past few years. While the picture remains foggy at this stage, a few signs may be pointing in that direction. It appears that equity markets have clearly chosen their camp over the past two quarters. However, it’s important to point out that the list of risks is paradoxically long and well publicized: financial stability in emerging markets, political risk in Europe, liquidity in the bond market, and currency volatility, to name a few.

Estimating Uncertainty
This state of the market may be well illustrated by the disconnect between the level of uncertainty priced by equity markets as shown by the Chicago Board Options Exchange Volatility Index® (or VIX,2 indicated by the blue line in the chart below) and the level of uncertainty apparent in economic data and news flow (as represented by the Global Economic Policy Uncertainty Index,3 indicated by the purple line).

Bloomberg chart

Making Sense of the Indicators
What this may mean is there is likely a strong consensus today in the marketplace, and that’s where I believe the principal problem lies. When opportunities and risks are clearly identified, and market participants seemingly price those to perfection, that is when financial markets tend to end up not having the anticipated response. 2016 started with heightened fears of a collapse of the Chinese economy and a Brexit meltdown. 2017 is starting on high hopes. The indication that something has to give could be rooted in the high level of policy and economic uncertainty. With equity markets pricing in high expectations, coupled with today’s rock-bottom equity volatility, now may be good time to reassess the equity component of portfolios.

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1 The term secular stagnation refers to a condition of low or no economic growth in a market economy resulting from a change of fundamental dynamics as opposed to cyclical or short-term stagnation.

2 The CBOE Volatility Index (the VIX) measures the implied volatility of the S&P 500® Index.

3 Economic Policy Uncertainty Index, March 2017.

This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.

All investing involves risk, including the risk of loss. Diversification does not guarantee a profit or protect against a loss.


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