Second Quarter 2014 – “Smooth Momentum”
Equity and credit markets ended the quarter on a high note, with the S&P 500 and the Barclays Capital Aggregate Bond Index appreciating 5.2% and 2%, respectively. Investors’ appetite for risk assets remained steady in the face of a surprisingly large negative revision to U.S. first-quarter GDP growth, uncertainty surrounding future monetary policy, and political unrest in the Ukraine and the Middle East. During the quarter, the S&P 500 completed 51 sessions in a row without closing up or down more than 1%, the longest such stretch since 1995. This constancy wasn’t just limited to the U.S. market; according to research from Goldman Sachs, implied volatility levels across 21 indices with liquid options markets were, on average, within two points of their 2005 lows. Some market strategists have postulated that extraordinary global central bank intervention and increasing levels of government regulation have constrained both the downside and the upside potential of the economy, thus reducing volatility. However, others contend that current market conditions are simply a result of where we are in the business cycle. Either way, long-term investors now face a much starker divide between risk and volatility. While return opportunities may have been dampened by a lower-volatility environment, risks (such as economic conditions and/or the impact of leverage and liquidity) may not necessarily have been lowered to the same degree. Thus, long term oriented investors have to resist the urge to take on imprudent risks for only incremental gains in return.!!