Conference Presentation, Panel
The Return of Volatility: Canary in the Coal Mine?
Milken InstituteMike Cloughton, Jillian Tett, Alex Friedman, Josh Friedman, Josh Harris, Alan Howard, Kerry Laidrock
- Global equities are expected to face significant volatility and a market pullback of approximately 10% within the next four to six months, potentially driven by a historical "market reset" cycle occurring every five to eight years.
- A "big market reset" or correction is anticipated to be a buying opportunity as the current central bank-supported "risk on" phase is believed to have about two years remaining.
- The global economy, currently described as "pretty spluttering," may experience "significant volatility" in the near future due to political risks not fully priced into the market and potential "unknown unknowns" with an odds occurrence of one such event within the next 12 to 18 months.
- Credit market instability is forecasted to arise from overshoot on credit due to systematic easing, with 10-year Mexican bonds potentially trading at 6% to 8%, and a lack of significant covenant protection in current bank deals compared to 2007.
- The U.S. fixed income market's reliance on daily liquidity vehicles could amplify downward trends if retail investors exit during a shock, while institutional investors like endowments and pension funds have been waiting on the sidelines for such opportunities.
- Future volatility may differ from the broad-based shock of the last financial crisis, showing instead "rolling structural volatility" across different industries and companies, though "unnatural buildups in disequilibria" will eventually necessitate an adjustment.
- Structural changes are predicted where asset managers replace banks as primary market makers, creating opportunities for those with "longer-term structural liquidity" while daily liquidity vehicles tend to sell during price declines.
- Interest rate normalization is expected to be a shock to the market; while the Fed is viewed as naturally dovish and cautious about derailing recovery, rate hikes—potentially occurring in the fall or early next year—could trigger a rapid rise in rates if pressure is released.
- Geopolitical risks, particularly the militarization of the Soviet Union around Ukraine, potential conflict in the Middle East, and increased Chinese aggression, are identified as larger threats than a potential Greek default or Grexit, though political instability from the Eurozone remains a medium-term danger.
- Oil prices are predicted to take one to two years to climb back to $70, and if prices remain at current levels for six to nine months, inflation in Japan and Europe could rise significantly, forcing central banks to stop quantitative easing.
- Opportunities are identified in European equities, particularly cyclicals, over the next six to nine months due to cheaper oil and currency, alongside specific plays in Japanese stocks and off-the-run credit in the crossover space.
- Negative rates in Europe are not expected to last, prompting an eventual sell-off of negative-yielding assets, while German bonds are predicted to correct dramatically and serve as a source of volatility.
- In the event of a 2008-style crisis, the government and Fed may need to guarantee approximately $20 trillion in liabilities again, as they remain the primary firewall, with regulators potentially using macroprudential policy to keep rates lower for longer, encouraging "eternal leverage."