Risk returns
Bumps in the road
Summary
After a bullish start to 2023, investors appear to be becoming more cautious. The collapse of two banks in the US has reminded investors of risk. We suggest that the policy actions to protect depositors in banks should (should) prevent a repeat of the financial crisis of 2007 - '08 (sometimes known as the Great Financial Crisis or GFC). But some economic impact is likely to be felt via banks becoming more cautious and risk appetite reducing.
Economic conditions in Europe are not as bad as feared as the warm winter has prevented an energy shock. China reopening and policy stimulation in that country should aid economic growth globally.
Central Banks are facing a risk that inflation may be more stubborn than previously anticipated, so may hold interest rates higher for longer but now are contending with financial stability risks that may demand more policy support.
Expectations around corporate profits growth continue to be cut, leaving the US equity market in particular, trading at full valuations. Profit margins are falling and until they stabilise we remain cautious.
Caution remains our watchword as the path forward could be clearing with more optimistic minds spying a trough in some economic indicators, but the risk is that this may prove a false dawn as higher interest rates continue to bite into economic growth.
A risk reality check?
Whilst the closure of two US banks is unlikely to trigger financial contagion we remain watchful, especially as the market appears to remain quite complacent.
With the recent rally there are signs that investor complacency has returned. The VIX index provides a guide to the expected volatility (or risk) priced into the US equity market. When it is elevated, as it tends to be during equity market shocks (a daily move of 2-5%), then it suggests that risk aversion is high.
Over recent weeks, the VIX index has fallen below 20. In our view this suggests that equity investors had been complacent about potential risk in coming months.
On news of issues at Silicon Valley Bank (SVB) the VIX index rose sharply (from under 20) and equity markets sold-off. Whilst the financial system impact should be contained, the economic impact is likely to be felt as investors and companies become more cautious.
For historical context, the VIX rose to heights of 80 during the Covid crash in March 2021, and often traded above 40 in other periods of market turbulence over the past 30 years. Risk aversion still appears to be quite subdued on this measure.
Equity investors became complacent through November and into 2023, but bank collapses have resulted in a reappraisal of risk appetite
Source: Bloomberg, Artorius
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