- 2018 has been full of surprises for investors, in stark contrast to the predictability that was a key feature in prior years.
- Nomura has nominated nine “Grey swan” events that could amplify or reverse recent market moves in 2019.
- It says one risk is a “big market quake” — a selloff in financial markets of extreme size. It believes US stock valuations, Italian government bonds and China’s enormous private debt levels are the most likely areas that could spark such an event.
2018 has been full of surprises for investors around the world, particularly for those who expecting a continuation of the much-mooted synchronised global economic upswing that helped to push risk assets sharply higher a year earlier.
That obviously didn’t eventuate, weighed down by a number of factors including tighter monetary policy settings from the US Federal Reserve, trade tensions between the United States and China and, more recently, spluttering economic data from Europe, China and Japan and signs of a slowdown in the US economy.
Few risk assets have fared well this year, especially those in emerging markets.
2018 clearly didn’t go to script for many investors.
After what’s been seen this year, many are now asking, understandably, what surprises lie in store in 2019?
No one knows that answer, but Nomura has more than a few ideas, releasing a list of nine “Grey swan” events that could dictate how financial markets fare next year.
The phrase “Black swan,” coined by Nassim Taleb, describes unforeseen events that can result in turmoil in financial markets. In contrast, Grey swan events are seen as unlikely-but-potential risks.
“For 2018, perhaps the only black swan event was the US-North Korean peace summit in June. As far as we could tell, no one was remotely thinking that was possible at the end of 2017,” Nomura says.
“As for the other outsized moves of 2018, such as the emerging markets FX selloffs, VIX spike and equity selloffs, these were grey swans — they were risks that many had highlighted, but turned out to materialise in a much more extreme fashion than expected.”
While the grey swans this year were largely negative for assets further out the risk spectrum, Nomura includes both events that could add to or reverse some of the extreme market moves this year.
Here’s the list in no particular order:
Shock 1: End of populism
Shock 2: Oil price plunges to $20 a barrel
Shock 3: The big market quake
Shock 4: Italian renaissance
Shock 5: Emerging market deflation
Shock 6: Chinese yuan comeback
Shock 7: Global growth takes off
Shock 8: Deflating euro area
Shock 9: Inflation sonic boom
While all, individually, would impact financial markets significantly one way or another, it’s shock three — “the big market quake” — that many will be eyeing off in this era of tighter monetary policy and slowing economic growth, especially given how most asset classes have performed this year after a stellar recovery from the depths of the GFC.
In Nomura’s opinion, “it’s easy to paint a picture of a market crisis in 2019” given the broader themes seen in markets and the global economy in recent months.
“There were the mini-quakes in 2018 from the VIX sell-off, the emerging markets FX collapse, trade wars, the Italian blow-out, Brexit and US stock correction,” it says.
“These could be precursors for the big one.”
Nomura says that even with the lift in financial market volatility seen this year, it still remains low compared to historical standards, meaning any market adjustment could see a “very significant increase in volatility and spreads”.
There’s three specific areas Nomura believes could lead to the “big one”.
“The three sources of imbalance are US stock valuations, Italian sovereign risk and China’s mountain of private debt,” it says.
“So collapsing stock prices, a contagious sovereign crisis in Europe and Chinese defaults would be the obvious manifestation of a market quake.
“In such an environment, cash would likely be king, risk markets would underperform and safe-haven currencies such as the yen would do well.”
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