Equity-market risk declined broadly in the second quarter, falling by some measures to levels not seen in more than 30 years, according to the latest edition of Axioma Insight: Quarterly Risk Review.
“Risk is on holiday,” says Melissa Brown, senior director of applied research at Axioma, citing the analysis of Axioma’s fundamental and statistical risk models covering global, regional and single-country equity markets. “Predicted volatility was down across the board compared with the first quarter, and down substantially in many cases from the second quarter a year ago.”
Given the low levels to which risk has dropped, and the ongoing conflicts in Gaza and Ukraine in particular, some observers assert that an increase in risk must be in the offing.
“We don’t think so, at least not in the near term,” says Brown. “Much longer stretches of low volatility have been recorded in the past, and besides, risk typically rises in advance of big market events.”
US risk rose fairly steadily in the three months prior to the market peak in October 2007, for example, and roughly doubled from its trough in January of that year. They then continued to rise in advance of the Lehman collapse in September 2008. In contrast, current risk levels have been trending down.
“In the US, second-quarter predicted volatility fell into the bottom decile of its levels since 1982,” says Brown, pointing to Axioma’s fundamental short-horizon risk model in particular. “And Axioma’s statistical forecasts do not suggest there is something ‘bubbling under the surface’ that other risk models are not picking up.”
Lower asset-asset correlations were a key driver of the decrease in second-quarter risk in most countries and regions, according to the latest Axioma report, as was lower volatility in markets. The declines in equity market risk were accompanied by decreased risk in currencies and investment styles.
Brown says: “The current low level of overall volatility means that asset dispersion—that is, the distribution of individual stock returns – is low. In other words, even the best stock picker has a tough time generating large excess returns in this environment.”
Japan recorded a substantial decrease in risk versus both the prior quarter and a year ago, but the fall-off may only reflect recently announced plans to reallocate the government’s pension fund toward more domestic equities.
“It remains to be seen whether fundamentals can sustain a further market increase, once that reallocation is completed,” says Brown.
