Bonhomie.
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.
QUIETER...and
QUIETER
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.
INDIA: THIS TIME IS
DIFFERENT…..ISN’T IT?
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.
THERE IS
PLENTY OF ROOM AT THE BOTTOM
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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