Bonds become more volatile than equities; checking on China’s reopening; and investors’ search for quality.
Bonds become more volatile than equities; checking on China’s reopening; and investors’ search for quality.
21 March 2023
A Significant MOVEment
As is usually the case when there are short-term shocks in the rate market, most of the action was at the middle and front end of the curve, especially the two-year point. To Friday 17 March, the two-year US Treasury yield had moved up or down by 15 basis points (bps) or more for seven consecutive sessions – the longest such streak since 1980 (Figure 1). Realised daily volatility on the two-year yield increased from 5bps during the first full week of March to 30bps on 17 March (Figure 1) – a sixfold change! Following the weekend's emergency consolidation of Swiss banks, there may not be any respite this week.
The increasing uncertainty in the market drove the MOVE Index (a measure of implied volatility in US government rates, similar to the VIX for the S&P 500) to a higher peak than during the Covid crisis (Figure 2). One interesting, and perhaps telling, phenomenon that we are witnessing is the level of equity implied volatility has been lower than rate implied volatility; historically, that hasn’t generally been the case. It is a symptom of the questions facing rate markets: will the Federal Reserve hike 25bps in March, 50bps, or not hike at all? Core inflation was up month on month in February, but will it start to ebb? Layer on top of all that the bank turmoil – which felt like a large, exogenous shock to the market – and it’s no wonder that uncertainty and thus implied volatility are sky high.
Going into this turbulence last week, short rates exposure was a popular position among strategies that proved painful. However, we are seeing a fair amount of performance differentiation between managers. We can attribute some managers’ relative successes to risk management and drawdown procedures. Namely, they stick to their risk tolerances, and they tend to cut risk quickly before a bigger move against them happens. They can also be very dynamic with their directional risks: it’s not uncommon for us to see a discretionary macro manager short interest rates one day, flip to long the next day, and be back to short in the next week. There have been some real diversification benefits to clients from having this type of dynamic, macro-directional manager in their portfolios. The market has been somewhat manic, but thoughtful risk management has helped many managers outperform.
Figure 1. US Treasury Two-Year Yield and 10-Day Realised Volatility
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Source: Bloomberg; as of 17 March 2023.
Figure 2. Implied Volatility of One-Month US Treasuries (MOVE) and S&P 500 Index (VIX)
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Source: Bloomberg; as of 17 March 2023. MOVE and VIX indexed to 31 December 2019.
Revisiting the Reopening
When it became clear that China was lifting its Covid restrictions and reopening its economy, we wrote that the resultant spending patterns may not replicate exactly those witnessed in developed markets as they returned to normality. We argued that any consumption boom was unlikely to be as broad or deep as consensus expectations; several months into the country’s emergence from strict lockdowns, we can review what has in fact happened.
Figure 3 reveals a significant bifurcation in the consumption of goods and services, with more-affordable discretionary spending rebounding strongly but larger-ticket items continuing to lag. February’s recovery in retail sales was thus driven by restaurants, alcoholic beverages, and apparel; in contrast, appliances and electronics remain weak, which we expect to continue.
We therefore maintain our view that China’s spending recovery will be narrow and modest, with select beneficiaries of the country’s post-Covid period including travel, entertainment, insurance and industrials exposed to GDP+ sectors, particularly automation.
Figure 3. Retail Sales in China by Category, Year-on-Year Change
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Source: Man GLG; as of 28 February 2023.
Quality Time
There has been an evident and understandable flight to (perceived) safety in markets, as illustrated most emphatically by the drop in Treasury yields last week. But what about movements within equities? The notion of a ‘safe haven’ stock is a difficult one, but we can observe that flows to Quality as a generic factor have been consistently positive, in contrast to the negative-to-flat trend across other factors (Figure 4). This makes intuitive sense given the prevailing macroeconomic uncertainty, not just through last week’s sudden turmoil but also the long hard/soft landing debate that preceded it.
Perhaps more intriguing is that other proxies for equity quality – such as Low Volatility or ESG – have suffered outflows through the same period, with Low Vol seeing the largest outflows. In theory, lower-vol stocks and those with higher sustainability scores should be a safer ports in a storm. Their lack of popularity can perhaps be attributed to other developments this year: investors seemed to be chasing high beta rather than low volatility through the strong rally that started 2023, and much of the Low Vol cohort is economically sensitive and has been whipsawed by the uncertain economic outlook. ESG, meanwhile, has faced problems from politics to performance, given such strategies typically overweighted lagging tech stocks and underweighted surging energy names last year.
Figure 4. Flows to US Equity Smart Beta Categories
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Source: Bloomberg; as of 15 March 2023.
With contributions from Jonathan Daffron (Man FRM – Deputy Head of Investment Risk), Andrew Swan (Man GLG – Head of Asia ex Japan Equity), and Rob Furdak (Man Group – CIO for Responsible Investment)
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