Global equities bounced broadly on Friday, following Mario Draghi’s ECB rate cut announcement on Thursday. We saw 8 positive surprises (at 95% confidence level) in Europe & Asia, as Fig. 1 shows. Was this just another one day wonder, or could this be a signal of a more sustained recovery in global equities?
Fig. 1. Ranking of positive outliers on 11 March using Global Equity FNA Correlations
Despite pervasive negative market sentiment, we’ve observed some interesting changes in outlier activity. After a rocky January which saw a synchronized plunge in global markets, positive surprises started to outnumber negative ones from Feb 3, and volatility started to decline in a synchronized rebound. Indeed, as Fig. 2 shows over the last 20 trading days, we’ve seen 20 positive surprises and only 1 negative one.
Fig 2. Summary of 20 day positive & negative outlier activity
Is the rebound sustainable? Positive surprises combined with moderating volatility bode well, and imply that risk parity and trend following strategies will continue to buy equities. However, systematic risk is still very high at 73% (about same level as the Aug 2014 Flash Crash, but with less coupling). This implies that we can’t count much on global diversification. Any surprise, for example a renewed China plunge, would likely have global repercussions. It therefore makes sense to remain cautious in position sizing. Asset allocation will be key to managing risk in markets with a high degree of systematic risk (e.g., in this case, balancing equity risk with US government bonds, which are the current preferred flight to safety asset with most reliable negative correlation to equities).
Here’s a short video where I review the global equities using FNA Correlations, and conclude by estimating the global impact of a China stress scenario.
Thank you for visiting, and looking forward to your thoughts and suggestions for further analysis and themes.