Is volatility imminent? Investors must not believe the benign backdrop will persist indefinitely…

18th September 2014

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As investors, we are in many respects living through some pretty gentle times.

Those who would counter that view by pointing to the bleak news emanating from areas such as Gaza and Ukraine must at least concede that markets would have reacted a good deal more negatively to such events had this been a more volatile period in the mould of 2008 or even 2011 writes Schroders fund manager Ian Kelly.

Even Mother Nature appears to be in a more benign mood so far this year – for example, as you can see from the graph below, data from the US-based National Oceanic and Atmospheric Administration shows the low level of tornadoes that have occurred in the States over the first six months of this year compared with much of the last decade.

Source: National Weather Service Storm Prediction Center, 13th July 2014

For its part, Munich Re observed in a recent research note that, in the first half of 2014, 2,700 people had died “as a result of natural catastrophes” – well down on the same period’s10-year average of 53,000 – although the insurer did add: “Towards the end of the year, the natural climate phenomenon El Niño may impact regions differently in terms of the number and intensity of weather extremes.”

In articles such as Don’t Look Back we have talked about the low levels of volatility currently being seen in share, bond and currency markets and also warned of the dangers of investors and companies being more complacent than the 134-year-old Munich Re by assuming the current benign environment will carry on indefinitely.

That would of course be to commit the behavioural finance sin known as the ‘availability heuristic’ – the idea human beings tend to ascribe greater significance to more recent events. Continuing the meteorological theme, a commonly used example of this is someone who lives in a hurricane-prone area but who has been unaffected for the last few years deciding they no longer need to bother with hurricane insurance – even though this is precisely the sort of time they should be thinking hard about the possibility of stormier times ahead.

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