One of the defining characteristics of the ongoing risk rally over the past 14 months has been its remarkable resilience in the face of epochal political shifts and a world at war.
Brexit, Trump, the near-miss in France with Marine Le Pen – all of those events had the potential to do lasting damage to market sentiment and yet none of them did.
Sure, a lack of progress in talks between the UK and the EU has weighed on the pound. And yes, Donald Trump’s learning-by-doing approach to being the leader of the free world has been a comedy of errors that’s pushed the dollar inexorably lower and kept a lid on Treasury yields. And sure, there were some signs of stress in European markets in the lead-up to the first round of the French elections. But the overarching point is that if you had been living in a cave for the past 14 months and someone showed you a chart of credit spreads and stock prices, you’d be forgiven for thinking that nothing very notable had happened during your year+ stint as a hermit.
Meanwhile, markets have managed to largely ignore the threat emanating from Pyongyang and we’ve become so desensitized to violence that most of us don’t fully appreciate the fact that Syria, Yemen, and to a lesser extent Iraq, are all essentially failed states that now exist almost exclusively to serve as battlegrounds for the proxy armies of Riyadh and Tehran to go about killing each other (that’s a horrific state of affairs, but alas, it’s true).
Importantly, all of the geopolitical turmoil described above is still manifesting itself on a daily basis. Even in France the political debate is hardly “settled.” And yet through it all, the BTFD mentality remains entrenched thanks largely to central banks and the perpetual motion machine that’s served to create what I recently described in a piece over at DealBreaker as “the wave paradox” (go read that, it’s good).
In fact, we’ve now gone nearly 10 months without a 3% selloff, and as Deutsche Bank writes in a new note called “Of Politics And Pullbacks”, that’s the 3rd longest since World War II:
Here’s some color from Deutsche:
A typical pullback in the S&P 500 is long overdue. Historically, 3-5% selloffs in the S&P 500 have occurred on average every 2-3 months. The current rally has now gone 10 months without a 3% sell-off, making it the 3rd longest since World War II without one. The only times an equity rally ran longer without a 3% + selloff was in 1993 (11 months) and 1995 (1 year). Year to date, several of the modest selloffs that occurred were associated with US political and geopolitical concerns and events–around the French election; the Comey dismissal; tensions with North Korea; US administration turnover and terrorist attacks.
So what usually happens around domestic and geopolitical event risk, historically speaking?
Well, as the bank goes on to write, “the S&P 500 trajectory around events historically has been of sharp short-lived selloffs [with] a median selloff of -5.7%; 3 weeks to find a bottom; another 3 weeks to recover prior levels; and significantly higher levels out 3 months (6.5%) and 12 months (13%).” Here’s a very interesting table:
As you can see from the title of “Figure 3,” Deutsche’s position is that “the economic context eventually dominates.”
Which leads us to the following quandary: in today’s world, where the pace of DM central bank normalization is all that matters and the ideal timing for an exit if you’re long risk or short vol. is “never”, what does it mean for “the economic context to eventually dominate?”
Because as we saw (again) on Friday, bad news is (still) good news.
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Fantastic analysis- thanks for sharing.
Agreed on the central banks point but I wonder about the other.
You say we’re too desensitized to violence to realize what’s going on, but I wonder if it’s really that in the West we’re actually increasingly remote from any conception of serious political geopolitical instability as something that might affect their investments as more than a transient shock. Someone 15 years into their career today would have spent all of it post-9/11. Someone 25 years into their career spent all of it post-Cold War. No one who has lived only in North America or western Europe has lived through serious internal upheaval in their own country. We’re so used to thinking of politicians as jokers that it can be hard to remember they’re actually driving the car.
This is certainly why so many people started out so sanguine about the prospects for a president who was very obviously, from day one, manifestly incapable of the leadership expected of him.
Curious that in many instances the sell off precedes the attributable event. In some cases surely sentiment turned negative in a deteriorating context and the event date was just the climax. But why did the 9/11 sell off start the day before? Conspiracy theorists anyone?