Business Insights

Weekly trending topic

Recent stock market volatility could be a sign of turbulence in the near future

September 15, 2016

It appears investors could be preparing for a rough ride very soon. The Chicago Board Options Exchange (CBOE) Volatility Index, VIX, also referred to as Wall Street´s “fear gauge”, which measures implied volatility in the S&P 500 index for the next 30-day period, has gone up more than 50% during September. For the first time since the assassination of John F. Kennedy, the S&P 500 has experienced swings higher than 1% for three consecutive days (MarketWatch, 2016).

 Numerous financial market experts are predicting turbulent times ahead for a stock market that has been relatively calm since the Brexit vote in June. Analysts from Deutsche Bank are predicting a fall of 8-10% of the S&P based on a combination of relatively weak economic indicators and uncertainty on interest rates, coupled with the upcoming election (YahooFinance, 2016). According to JPMorgan, the market is so unstable that “even a tiny bit of volatility could unleash a USD $100 billion cascade of selling” (Barrons, 2016)

September has historically been the worst month for stocks, and a fall in the S&P superior to 10% in the last quarter, has only occurred once in the last 20 years (CNBC, 2016). A recent report by McKinsey illustrates that short term instability does not usually translate to prolonged losses, so long-term investors should maintain general optimism on their portfolios (McKinsey, 2016).

 The IPC in the Mexican Stock Market has fallen almost 4.5% in recent weeks, led in part by a downgrade of Mexican banks by rating companies S&P Global Ratings and Moody´s Investors Service in late August, yet specific fears on banks could be overblown. According to UBS, there is no recessionary risk and Mexican banks have displayed sound finances: “from a balance-sheet perspective, Mexican banks are extremely well capitalized” (Bloomberg, 2016). Nevertheless, the Mexican economy has clearly been undergoing periods of uncertainty, more than other emerging economies, as a potential Trump presidency has been affecting the Mexican Peso MXN, and posing a threat to long term economic instability in the country (BloombergQuint, 2016).

 We approached Jorge Martinez, CFA, Dean of Finance at EGADE and Managing Director of MG-RISK, about his perspective on the economic outlook:

 In recent days, the stock market displayed volatility driven by a possible interest rate hike and other factors. The FED later hinted rates may not rise immediately, yet there seems to be a feeling of concern regarding a considerable sell-off in the near future based on current overall conditions. What is your outlook in the short to medium term? 

 Market volatility has been undergoing erratic behavior in recent weeks, all types of assets in the US, Europe and Asia – and especially Latin America. These changes are due to the election in the United Stated and the exit of the UK from the European Union. The general equity, money exchange and commodities market have had a strange volatility below its previous years´ average (around 15% annual), coupled with low capitalization and thus low liquidity in general, in all the markets. The risk-off sentiment (to avoid threats) has been affected by potential interest rate hikes by the FED. Its last increase in December led to steep drops in high-return Latin American bond portfolios in the United States. On the other hand, we know that low volatility causes even lower volatility going forward, since this indicator has memory. At the same time, we know that low volatility leads to improved returns in the stock market and financial assets in general; nevertheless, this has not happened lately and the value of risk coverage, which often falls with low volatility, has instead increased significantly. This phenomenon is really unusual. It is reflected by low ratings in the Chicago VIX, the key volatility index, but on the other hand the uncertainty sentiment has also been portrayed in low investments in the United States in inventories, fixed assets, machinery, equipment, and intangibles, which clearly reflects the effect of the upcoming elections, affecting other important aspects such consumption, and business and government spending.

Going forward, we can expect the typical “calm before the storm” syndrome and higher volatility and extreme highs in the upcoming months after November and after the FED´s decision to increase interest rates. We can expect a continuous period of uncertainty accompanied by high volatility, which will eventually diminish beginning in the first quarter of 2017.

 Volatility has also been strongly reflected on the Mexican Peso MXN, which has been the most affected currency in the world by uncertainty and it has been referenced in general as an index to display different visions of emerging markets, which have felt the effect of the increased demand for commodities, but at the same time have been strongly affected by expectations of the increase of interest rates in the US, which has displayed signs of a strengthening labor market and wages, but with low capital investments. The year to date depreciation of the Mexican peso is similar to England, which is clearly unjustified. In fact, the Brazilian Real – whose economy is fundamentally weaker than Mexico – also displays a curious phenomenon which leads to the obvious conclusion that the Mexican Peso has had to suffer – being an indicator – the effects of the market and expectations of the interest rate hike on emerging economies, in addition to increased demand on international consumer goods by China.

About Jorge Martínez

Jorge Martínez, CFA, is currently Dean of the Masters in Finance Program at EGADE. He is also Managing Director and Founder of MG-RISK, a consulting firm in risk management, financial strategy, economic studies and applied research, based in Monterrey, Mexico. He was previously Chief Economist at Cemex and has held key positions in leading financial institutions for over 20 years.