What could possibly go wrong? That’s the title of a recent research report from Source Research the multi-asset research outfit, founded by ex SocGen analysts. It seems the analysts at source are playing to investors’ fears. After a low volatility summer, there’s plenty of speculation going around that volatility could return with a bang during autumn and winter months. Indeed, there are a number of risk events coming up over the next few months that could spark a sudden sell-off if the outcome is not what the market expects. Chief among these risks is the US presidential election in November and before that, in September there’s the Fed’s rate decision.
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July and August saw some of the lowest implied volatility on the S&P 500 in history. Throughout August at the VIX averaged just over 12, compared to the average since 1990 of around 20. Four July the VIX reading averaged 13, compared to the average since 1990 of 18. Volatility tends to be subdued throughout the early summer months. The VIX average since 1990 for April, May, June, and July is 18, but the index has tended to rise to an average of 20 for August, 21 for September and 22 for October before declining into the Christmas trading period. In other words, if history is anything to go by volatility will spike over the next few months.
Volatility is low, buy gold and bonds
So what could go wrong and what should investors do about it? The analysts at source are planning for several scenarios. One obvious problem would be a weakening of US and Chinese data. If the data deteriorates further, it could push the Fed to delay another rate hike, which the market would enjoy but increases the risk of instability further down the line. If this scenario plays out, source expects a replay of the turn of the year, where gold and quality sovereign debt outperformed at the expense of oil, base metals, and equities.
Another market catalyst could be a further decline in the price of oil. Source believes equity markets are still overly optimistic about oil prices and predicts that a break below $40 could spur a seasonal spike in volatility. Once again in this scenario gold and sovereign bonds are favoured. High yield and energy stocks are expected to suffer.
After Brexit, European politics is now becoming more unpredictable. The next potentially damning European political event is slated for October or November when the Italian constitutional referendum will take place. In theory, a rejection of the government’s proposals could lead to the resignation of the PM, new elections, an anti-EU government and a referendum on EU membership. If this does play out, source is predicting a re-run of the events following Brexit. European bank stocks are likely to suffer along with peripheral country debt.
And lastly, the most significant event on the calendar for the next few months is the US presidential election. While US presidential elections are not usually a market shaping affairs, the “maverick” nature of Donald Trump complicates matters. Gold and quality government bonds should benefit.
Overall then, to protect your portfolio against any of the uncertainties that may arise over the next few months, it looks as if gold and quality government bonds are the assets to own if source is to be believed.