Are we experiencing an unsustainable risk situation in the financial markets? While many gurus announce a sharp drop mainly in the bond environment, taking advantage of an always volatile month of August due to less liquidity, the US stock markets continue to set highs with revaluations in the year that generously exceed two digits. Similar gains are recorded in Europe, also at levels never seen before (as usual, this is not the case with the Ibex 35). The market sees an overcast sky of indicators, which may convey concern about the risk of an upcoming correction, but which coincide with an excess of liquidity in the pockets of investors, lacking other alternatives that offer profitability at lower risk; a summer period, in which trading is drastically reduced,
A panorama that is mixed with favorable forecasts on the progress of the economies during this and next year, which are only overshadowed by the possible withdrawal of stimuli from the central banks, more advanced in the United States, and by the evolution of the pandemic that threatens with more contagious variants of the virus, such as the current Delta.
Javier Méndez Llera, secretary of the Spanish Institute of Financial Analysts (IEAF) considers that the risk is relatively high. “Certainly well above the average perceived risk from the end of last year to the first quarter of 2021.” And he attributes this situation to the change in the attitude of the Federal Reserve in June “which generated quite a bit of noise in the markets that month; without assuming the tapering tantrum of 2013 but warning” of what it may announce at the return of summer. However, the Fed has shown commitment to adjust the monetary policy stance if risks arise that could prevent the achievement of the objectives and reiterates whenever possible that the rise in inflation is temporary.
The money, then, is pending what the central banks do. And not only in the fixed income environment but also in the stock markets that are compared and valued with it. From the Madrid Stock Exchange, they explain that we are facing a new reality of interest rates that do not allow comparison with historical situations. Zero rates, negative nominal rates, and, more recently with rising inflation, negative real rates in all developed markets. “If we applied those rates directly, the Stock Exchanges could be even higher. To value the Stock Exchanges right now, reasonable levels of risk-free interest rates and also reasonable risk premiums are being used,” they indicate from this square.
However, IESE professor Pablo Fernández points out that, as interest rates on government bonds have fallen, many analysts and consultants in the US and Europe are using what are called normalized risk-free interest rates that It is a risk-free rate. According to the teacher, this gives rise to assessment errors. According to data from MSCI, the PER (times the price contains the benefit) on the US stock market would be 29 times, compared to the 21 times the monthly average since 1990. Although, the current one is 27.1. In the case of Spain, the current PER of the Ibex would stand at 30.10 times compared to an average of 15.78 times – now it is at 18.65.
This feeling of low risk in the markets reflected in a Vix volatility index that is having a very stable behavior, and that accumulates a drop of 35% compared to a year ago, logically comes up against the day-to-day of the markets. But the positive evolution of the business results corresponding to the first semester supports the good moment of the stock markets, with increases of 70% in the S&P 500 index from the lows of 2020. These are the main risk indicators:
Coverage increase
The highs in bonds and the Stock Market, the scares coming from Asia, the uncertainty of Covid-19, are raising the levels of coverage in the portfolios to maximums. Ignacio Cantos, director of investments at atl Capital, explains that although “volatility is very low, investors have taken the purchase of put options (sale) to maximums in the last month in order to cover their positions. In a report from Macro yield, Antonio Zamora and Patricia García explain that the Skew index has reached all-time highs. This index measures the difference between the cost of derivatives that protect against large market falls, on the one hand, and the right to benefit from a rebound, on the other.” Skew goes up when fear outweighs greed,
Retail investors at highs
The latest data from the Fed show that the level of retail participants in the market is at an all-time high, with 29% of shares and 40% of financial assets (banks). Previous highs in household participation were followed by low equity returns: 1969 (1970s inflation), 2000 (tech bubble), and 2007 (global financial crisis). However, Ben Laidler, global markets’ strategist at the eToro platform, believes that it is now different due to the structural change of the online community, free trade, fractional ownership, and more investment options. Also, the low yields of bonds and rates, and, finally, an excess of savings of 3.3 trillion and a household debt over GDP of 20 percentage points below 2008.
Rotation towards higher-quality assets
A warning about the risk of the markets has materialized with a transfer of the investor towards higher quality stocks, which indicates that the process of rising is mature. Aneeka Gupta and Pierre Debru, directors of analysis at WisdomTree, explain that this trend is accelerating and a good example is that in the second quarter of the year the quality factor (+10.88%) outperformed the profitability of cyclical factors such as to that of value shares (3.4%) and small caps (5.4%). Something that has also happened in the Spanish stock market whose profitability is led by the Ibex 35 (10%) against the Medium Cap (6.34%) and the Small Cap (3.93%).
Leverage with shares
Margin debt, known as the amount that individuals and institutions borrow against their stock holdings, appears to have reached a peak last month, according to data from the US Financial Industry Regulatory Authority (FINRA). Comparing the year-over-year change in margin debt levels to the S&P 500 index shows that spikes in margin debt levels have been an important precursor to US stock market corrections, as seen in 2000 and 2008 during the dotcom bubble and the great financial crisis.
