But, while geopolitical risk is high at the moment, markets on the whole have continued their ascent largely unhindered, which begs the question: how worried should one be as an investor?
By most measures of market risk, the answer to that question would have to be, not too worried, because in most jurisdictions, risk levels have seldom been lower.
According to Axioma Insight’s Melissa Brown, US risk is at its lowest since at least 1982, while UK risk measures are sitting roughly where they were at the end of 2012.
Indeed, she says, the decrease in risk that started in April has continued throughout the third quarter in many regions. And, in developed markets, individual currency volatility has fallen substantially.
For Brown, while there are clear geopolitical concerns, risk spreads suggest that there is nothing bubbling under the surface that might lead to a sudden pop in risk.
One concern with this, however, is that the most frequently-used measure of risk is volatility and, it is an imperfect measure, something Brown acknowledges. (More on the debate about volatility as a risk measure can be found here)
But she points out, it does have some benefit.
As can be seen from the graph below, she explained, such low levels of volatility are not unprecedented and, in fact, have lasted much longer in previous cycles. Importantly, she adds, when markets have crashed, they have tended to be foreshadowed by an increase in volatility.
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Source: Axioma
Not out of the woods
While a rise in the level of market volatility may not be imminent, there are other reasons not to get complacent.
First, the obvious investment strategy for those investors that do want to take a little bit more of a defensive posture – the developed market sovereign bond – is not looking particularly attractive, this means that in order to go defensive, investors are having to move increasingly out of their comfort zone.
For Aviva Investors’ Nick Samouilhan, there are a two other major concerns. The first is the geopolitical risk mentioned above, which he believes isn’t being properly priced in.
Geopolitical risk is seldom properly priced in because it doesn’t fit easily into the market’s risk models,” he said.
The second concern Samouilhan raises is a political one.
“There is a quite complex, quite delicate hand over going on in the developed world between what was largely a policy-driven support mechanism in the UK and the US chiefly through monetary policy to one wherein the private sector steps up as investment and consumption pick up. And, because the data that the central banks have is backward looking, you can easily see a mistake being made there. Policy risk is pretty high at the moment and I don’t think people are pricing that in properly.”
The final concern for Samouilhan is that in a situation like the one in which we find ourselves, where volatility is quite low, where buying equities has been rewarded where there is good news in markets,
“The danger is that everyone gets positioned the same way and that makes it a very fragile environment because if there is any news flow that comes out that causes us to question things, if all of us are positioned the same way we all have to run for the same very small door.”
While volatility remains on the low side, there are clear reasons to be worried. Perhaps now is the time to make sure all the storm shutters work and the that the flash lights are all in working order, just in case.
