By: Tim Bennett
10.05.2018
10.05.2018
Three market stress measures investors should monitor in 2018
Having dipped sharply in February, stock markets have recovered their poise. So what next? This week I highlight three early-warning signals that have been getting a lot of press coverage and explain what they reveal and how investors should react.
The early warning trio
Whilst there are many signals that investors could monitor, the following are being closely watched so far in 2018;
What follows is a quick tour of each one.
The LIBOR/OIS spread
This jargon-filled phrase can be translated roughly as “the difference between what banks charge each other for short-term funds and what they are charged by the central bank”. Sure, that’s a rough and ready definition of what is quite a complex spread in reality but it will suffice for anyone other than Treasury boffins. In short, the wider the gap, the more nervous observers tend to get. The question is whether, or not, this is justified. On the next two slides, I have summarised;
· What the spread represents
· Why investors worry when it widens
· Some reasons why they shouldn’t panic (the second slide)
As this second slide points out, there are some fairly harmless, even benign, reasons why this spread may have widened recently. For example, if companies are expanding and spending money and buying fewer bank bonds, this spread may widen for essentially positive reasons. As such, be careful reading too much into negative headlines on the basis of just one indicator.
The Treasury yield
This is the return available (gross redemption yield) on a benchmark 10-year US government-backed IOU. Many other forms of debt are priced from this yield as it is viewed as a reliable “risk-free” return. The next two slides summarise, as in the last section;
· What the yield represents
· Why investors worry when it rises
· Some reasons why they shouldn’t necessarily panic (the second slide)
The VIX
This wisely quoted number reflects the price of buying insurance in the equity market (options contracts). The higher the index, the higher the premiums being charged and the greater the “fear factor”. However, whilst simple enough to understand and read, it is not without its flaws. That’s why investors shouldn’t necessarily panic when it spikes short-term. Once again, here is a summary of;
· What the VIX represents
· Why investors worry when it rises
· Some reasons why they shouldn’t necessarily panic (the second slide)
Conclusion
I have warned before about the dangers of watching headlines too closely. My message here is that whilst all three of the measures covered are used frequently as barometers of market stress levels, each can also be interpreted more benignly. As ever in financial markets, cool-headed interpretation is the key. Do contact your Investment Manager if you would like to discuss this area in more detail.
