The complacency conundrum October 2017

On October 19 1987, the Dow Jones Industrial Average fell 22.6% as concerns about valuation were exacerbated by new program trading techniques and systematic hedging strategies. Thirty years later, at least some of the characteristics of Black Monday are beginning to echo uncomfortably.

With developed equity markets still posting very strong risk-adjusted returns, are investors complacent or not?

  • Very low levels of implied volatility have not prevented equity returns from rising historically; major drawdowns have all occurred from higher implied volatility starting points
  • MSCI World’s 436 trading days without a 5% drawdown over three months is fifth longest since 1969—but lags significantly behind 736 day record
  • QE reversal likely to have only marginal impact on market volatility in 2018
  • High degree of skepticism about valuations and constant challenge to market supports in contrast to peaks of previous market cycles
  • Rising geopolitical risks, extended hedge fund positioning and a new Fed chair have the potential to disrupt markets in the short-term but we see scant evidence of widespread complacency
  • Strong macroeconomic backdrop, valuation support against bonds suggests further upside to equity markets
The complacency conundrum