The biggest challenge facing investors at the moment is that markets may be underestimating the risks because volatility has remained at low levels, and this may indicate market complacency.
“In general, we’ve been in a low volatility regime, which means that people feel good about the market. We’ve actually been flirting with what we call euphoria, which means people are quite complacent,” Michele Barlow, Asia-Pacific head of investment strategy and research at State Street Global Advisors (SSGA), tells The Asset in an interview.
“This has been playing out in the market and it has been very good for equities over the last number of months. But there is the potential for that risk to rise as we go into the second half of the year,” Barlow explains. “The risk could come as a surprise in terms of economic growth slowing, inflation picking up in a big way. That would create certain risks to the market as well.”
The standard gauges of risk such as the CBOE volatility index (VIX) remain at historical averages, and the cost of hedging against equity drawdowns, currency depreciation, or credit deterioration remains well below post-pandemic averages and close to the multi-cycle lows seen in 2023, according to the SSGA’s 2024 global market outlook.
The exception to this has been the recent higher volatility in bonds and currencies and a sharp rise in the demand for gold on the back of a surge in demand from Chinese state-back entities and retail buyers.
Investors should be prepared for increased volatility as geopolitical unrest is likely to continue impacting commodity prices and further clouding risks related to inflation, according to Barlow.
Although headlines have been dominated by uncertainty around the future path of the US Federal Reserve’s decision on when and by how much it will cut interest rates, a soft landing of the US economy is still possible.
SSGA expects three to four interest rate cuts this year, with the earliest possibly happening in July.
Risk assets have proved resilient in 2024, although the anticipated bond bounce has not yet materialized. Rate cut expectations have been trimmed amid persistent inflation but SSGA maintains its forecast of a soft landing. Still, risks for investors warrant attention, according to the firm.
For investors, this means that they have to remain cautious on risk assets and favour quality stocks in the equity markets while recognizing that bond markets will struggle because of stickier-than-expected inflation.
On the bright side, risk assets have remained resilient in the face of increased uncertainty, while fixed income remains a bright spot for investors given the current yield levels, slowing growth, and continued disinflation.
Given this market environment, investors should remain focused on right-sizing their positions and getting portfolio implementation right while retaining flexibility to be able to respond to clearer market signals.
