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"Our scars have the power to remind us that the past was real."


So much of it wafts through the market air currently. Hannibal Lecter’s quote from Red Dragon in the subject line wells up in one’s head. (Though some would counsel against letting Dr. Lecter crawl into one’s brains.)

The past decade has seen a major change in the way market participants think about positioning. Like a responsible parent helping toddlers to get on their feet, central banks globally have held the market’s hands through periods of disquiet. We have learnt to walk, indeed. Conditioning has nudged us to presume the parent’s omnipresence during future periods of turmoil. Assorted naysayers, bear mongers have been shaken out. Converts and survivors from The Resistance have taken to trend following, along the path of least resistance. Up. Momentum plays on liquidity – the ETF brigade – have added to the crowd. The zigging and zagging of prices – Volatility – has progressively entered hibernation, as a result.


Volatility tends to bear an inverse relationship with prices. It also tends to cluster together. As prices have gone up, volatility has gone to sleep. The low volatility regime of the present day is a result of several factors. Low interest rate regimes globally, central bank parenting, rise of ETFs. Conditioning has pushed some of the adventurous to making open bets against market downturn. Underlying presumption being a continued upward trend in prices. Helpful global central banks are in U-turn mode from their easy money stance. Interest rates have U-turned as well. The rise of the volatility sphinx has been proclaimed before. But central banks have repeatedly drowned out callers’ tunes. Though low by historical standards, a lift-off of interest rates from the zero bound has the potential to trigger quick price reversals. With no real experience with this ogre over the past decade, we may have occasion to remember Hannibal Lecter soon.   


There is little to not like here. Financial savings wave, systemic clean up, and a government that plays the adoring parent’s role. Demonetisation categorically resolved the debate around competing investment avenues. Real estate and gold has receded from minds. Falling bond yields pushed fixed income out of market mindshare. Leaving the only game in town: equities. Indians have latched on and how. Domestic investors poured more capital into equity than the 2006-16 period combined. Many of these are first-timers entering the equity market in a meaningful manner. With a preference for smaller-sized companies. This group has had little experience with either volatility, or a large market drawdown. Meanwhile, interest rates have been quietly inching higher.


The average small cap index drawdown over a 1-year period has been -30% historically. The post-DeMo new investor group has never had to confront deep valleys before. A low volatility world combined with no drawdown experience makes this group particularly vulnerable to sharp downturns.

…which, one is led to believe, will be bid into with confidence.

The easy money of 2017 is likely history. Scars could remind us, yet again, that the past was real. 


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