Markets have been eerily quiet of late, contrary to late 2015 and earlier this year.
Powered by the twin factors of summer holidays in the Northern Hemisphere and the belief among the vast majority of investors that central bank policy will remain ultra loose for the foreseeable future, risk assets have enjoyed a stellar run over recent months, sans the brief market turmoil sparked by the UK Brexit referendum.
In particular, bonds and credit markets, especially in emerging markets, have rallied hard, boosted by a rebound in the crude oil price and diminished expectation of US rate hikes in the period ahead.
This is no better demonstrated than in the heat map below from Deutsche Bank. It tracks fund flows into various asset classes — both in developed and emerging markets — as a percentage of their net asset value, going all the way back to 2006.
The theme seen so far in 2016 is clear to see, in many instances the opposite to what was seen last year.
Beaten down asset classes, on the nose in 2015, have been in demand, attracting capital despite a period of market turmoil associated with the Chinese economy earlier this year.
Although this trade is working nicely at present with volatility close to non-existent, a number of analysts are warning that this trend may be about to come to a shuddering end.
According to Athanasios Vamvakidis, Adarsh Sinha and Yang Chen at Bank of America Merrill Lynch, the quiet northern summer is keeping investors complacent, and seriously exposed to a future spike in volatility.
“While it is uncertain where the next shock will come from, we believe there are several possibilities,” they wrote. “To name a few: a faster Fed hiking cycle than the market is expecting, US election uncertainty, and turmoil in Italian banks.”
No matter how it happens it is going to happen eventually, they say.
As a consequence, they suggests that investors should “be fearful when others are greedy.”
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