Broad examples of divergence, across many asset classes and geographies, could be an indicator that markets are headed for more turmoil than the surface appearance currently indicates, according to a strategy note from Unigestion.
Divergence refers to a phenomenon when segments of financial markets that tend to move in sync begin to do the opposite. In stocks, for instance, the S&P 500 was up 2.8 per cent in August, while the EuroStoxx50 fell 3.5 per cent, and the MSCI emerging markets index fell 4.5 per cent. Within sectors, divergence also popped up, with European information technology stocks up one per cent over the month while financials fell by eight per cent. Fixed income wasn’t exempt either, with the U.S. 10-year bond yield declining from 2.96 to 2.83 per cent, while the British 10-year rose from 1.33 to 1.43 per cent.
Read: Equity investors facing uncertainty, volatility as path to de-globalization continues
“Last year was characterized by stable and synchronized growth and this year is more uncertain,” says Guilhem Savry, head of macro and dynamic allocation at Unigestion and manager of its multi-asset navigator fund.
With macro considerations such as a broadly changing interest rate environment, tax reform in the United States, as well as protectionist trade conflicts between several countries, there are two potential paths for the investment environment, says Savry. The first would be the U.S. leading the pack in terms of economic activity and the rest of the world slowly catching up to its growth, which would be more positive for investments overall. The second scenario, which Savry says is more likely, would include the U.S. continuing to insulate itself, resulting in a spike in ongoing geopolitical tensions and much higher levels of volatility going forward.
Read: Watch equity markets closely as trade tension continues: experts
Within this context, high dispersion is a red flag, and investors should monitor areas of tension and disruption. These include trade war risks, as China and the U.S. continue to trade blows, Italy’s political upheaval and the possible implications for Europe’s overall financial stability, as well as the possibility that the U.S. Fed and the European Central Bank may diverge on policy, according to the strategy note.
In this environment, it’s key to examine multi-asset strategies to ensure they’re not overly reliant on growth-seeking assets because they won’t be as resilient in an adverse scenario, the note emphasized. Sovereign bonds, risk managed equities and defensive currency strategies all contributed to smoothing dispersion from returns in recent week, it said.
Read: Top 40 Money Managers: Charting the course through choppy waters