Managing volatility

Some fear too much growth, others too little. In either case, the markets' increased volatility should be manageable.

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    Multi Asset

    Multi Asset

    Managing volatility

    Some fear too much growth, others too little. In either case, the markets' increased volatility should be manageable.

    In retrospect, 2017 would have been an almost perfect year for relying on the autopilot. But in 2018, investors have to be wide awake: focused on the road, with both hands on the wheel and prepared to change direction and speed at a moment's notice.

    Although only in its early stages, 2018 has already put an end to last year's serenity. On February 8, after more than 400 days, the S&P 500 ended its longest stretch to date without a 5% correction. What's more, the U.S. stock index has already experienced 20 fluctuations of more than 1.0% year to date, two-and-a-half times as many as during the entirety of 2017. And the Vix , which represents the implied volatility of the S&P 500, registered its biggest single-day increase ever on February 5, both in percentage and absolute terms. In 2017, the Vix remained below 10 for 55 days, which is indeed remarkable given that it had only spent 10 days below the 10 level from its introduction in June 1990 until the end of 2016.

    The first doomsday scenarios began to circulate when the S&P 500 slid below its beginning-of-the-year level for the first time on February 5. Since then, most markets have hovered around their end-2017 levels, with increased volatility. If high volatility is defined as being above a threshold of 20 points in the Vix, the high-volatility period in January and February lasted for 21 trading days. The next phase of wild market swings began on March 22. According to this definition, 2017 did not experience a single day of high volatility (see chart). Investors have to look back to the beginning of 2016 to find a longer period of higher volatility.

    Our market forecast...

    What will happen next? Volatility seems to have bottomed in 2017. The current interest-rate cycle and signs that the major central banks (Eurozone , Japan, United States) may start to reduce their balance sheets (by the fourth quarter of this year at the latest) can no longer be ignored by markets. We have identified the return of the Phillips curve as a major risk scenario for the next one to two years, and one which can be even more severe should the curve return in a non-linear shape. The risks of a more pronounced acceleration in labor costs would rise if labor markets continued to tighten, increasingly so if that tightening were to intensify.

    However, this is not our base scenario. We don't expect a significant upward movement in inflation or interest rates in this cycle. The Fed might end its rate-hike cycle at around 3%. We still expect a more volatile year, as investors will have to come to terms with the rise in interest rates and fears about overheating. But the synchronized global recovery should, at the same time, continue to act as a safety net and could prolong stock markets' late-cycle glow. Sudden spikes of volatility cannot, however, be ruled out, even though average volatility is expected to rise only slightly in the medium term.

    ...and how we position ourselves accordingly in multi-asset portfolio management

    In the face of potential volatility spikes, we will not pursue any strategies that take an aggressive short-volatility position. There are certainly more elegant ways of benefiting from volatility or changes in volatility. For example, investors can take advantage of price inconsistencies resulting from the convexity of volatility products. Also appealing is the writing of put options – in other words, covered option transactions. This strategy has become even more interesting due to the slight rise in the average volatility level. The second chart shows an example of how an investment in an S&P 500 put option index would have performed, together with a corresponding cash amount invested in an interest-bearing instrument as collateral. The index performed similarly to the S&P 500 over a period of 20 years, but with significantly lower volatility.

    Back to normality

    2017 has been a particularly calm year for equity markets. The Vix never topped 20. The chart shows the length of past high-volatility periods.

    Sources: Thomson Reuters Datastream, Deutsche Asset Management Investment GmbH as of 3/27/18

    * A high-vol period ends when the Vix trades below 20 on more than 4 consecutive days.

    Almost the same result with less stress

    Selling S&P 500 put options yielded similar results as buying the S&P 500 long over the past 20 years, but with less volatility.

    Sources: Thomson Reuters Datastream, Deutsche Asset Management Investment GmbH as of 3/27/18

    *CBOE S&P 500 PutWrite Index

    next chapter

    Allocation

    Allocation

    Goodbye to Goldilocks

    More volatile and lower-yielding markets should be manageable.

    Volatility has returned, and belief in the Goldilocks scenario is waning. Our macro outlook remains optimistic, but we anticipate nervous markets. In this climate, we slightly prefer stocks to bonds. We foresee only slight differences between regions and rather select on the basis of asset type and sector. In the United States and the emerging markets , we continue to like momentum stocks such as technology. In Europe and Japan, we prefer value stocks. Where bonds are concerned we remain tactically agile and combine defensive and cyclical bonds – the former through floaters , for example, and the latter through emerging-market bonds – in a barbell strategy. We are avoiding corporate bonds in developed markets.

    The chart shows how we would currently design a balanced, euro-denominated portfolio for a European investor taking global exposure. This allocation may not be suitable for all investors and can be changed at any time without notice. Alternative investments involve various risks and are not necessarily suitable for all clients or for every portfolio.

    Source: Multi Asset Group, Deutsche Asset Management Investment GmbH as of 3/28/18

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    Indicators

    Indicators

    April weather

    The skies cloud over

    After 12 almost carefree months, the skies over markets have become cloudier since the beginning of 2018. All three DWS indicators have slipped. The good business climate of 2017 led to rising analyst expectations that now leave little scope for positive surprises. Europe, which has fallen from very positive to deeply negative since the start of the year, has been the main source of strain on the DWS surprise indicator. In Asia and the United States, by contrast, the indicators have risen year to date. Worldwide, however, positive surprises barely have the upper hand now.

    Many investors were taken by suprise by the market correction in early February which dampened their risk appetite. Higher market volatility impacted the DWS risk indicator. As early as in mid-December 2017, our liquidity measure has been indicating a slight degree of tension, which has further weighed upon the risk indicator. As a result, the indicator has signaled a negative environment since early February. Although the DWS macro indicator has declined of late, three sub-indicators remain at maximum levels, pointing to a sound macroeconomic environment. Therefore two of the three DWS indicators are still positive.

    Macro indicator

    Condenses a wide range of economic data

    Source: Deutsche Asset Management Investment GmbH as of 3/16/18

    Risk indicator

    Reflects investors’ current level of risk tolerance in the financial markets

    Source: Deutsche Asset Management Investment GmbH as of 3/16/18

    Surprise indicator

    Tracks economic data relative to consensus expectations

    Source: Deutsche Asset Management Investment GmbH as of 3/16/18

    previous chapter
    01. Jun 2018

    Americas CIO View

    Is it time for U.S. Small Caps to shine? If you pick them right

    08. Jun 2018

    Chart of the week

    In some areas, Italy is actually doing quite well

    01. Jun 2018

    Chart of the Week

    Why emerging markets may be less vulnerable than they used to be

    Chart of the Week

    Why emerging markets may be less vulnerable than they used to be

    29. Mai 2018 Equity

    The Euro, Italy and how we reached our dollar call

    Italy's political woes are dragging down markets while boosting our dollar call.

    16. Jul 2018 Investment Traffic Lights

    Americas CIO View

    How much Value is to be found abroad?

    13. Jul 2018

    Chart of the week

    China's monetary base looks set to grow faster again soon

    06. Jul 2018

    Chart of the week

    On trade, the Trump administration might have some powerful allies.

    03. Jul 2018

    Investment Traffic Lights

    Our tactical and strategic view

    19. Jul 2018 CIO Special

    Dollar pros and cons

    The dollar has already reached our target. Currently, the arguments are balanced.

    20. Jul 2018 Focus Topic

    Let's make finance sustainable

    The march towards sustainable finance looks unstoppable.

    19. Jul 2018 Macro

    Fasten your seatbelts

    The outlook for the global economy continues to look solid, but risks are growing.

    19. Jul 2018 Multi Asset

    A never-ending late cycle

    Still, the good economy just about trumps bad politics – and we remain optimistic.

    19. Jul 2018 Equities

    Cautiously optimistic

    For the time being we are focusing more on sectors than countries.

    20. Jul 2018 Macro

    A Closer Look

    How tight is the U.S. labor market?

    13. Aug 2018 CIO Flash

    Turkish troubles persist

    Turkey keeps investors nervous. But economic contagion should be limited.

    10. Aug 2018 Chart of the Week

    Beijing made its point. For now, we believe it is happy with the renminbi where it is.

    Chart of the week

    03. Aug 2018 Investment Traffic Lights

    Investment Traffic Lights

    Our tactical and strategic view

    02. Aug 2018 Americas CIO View

    Americas CIO View

    EM Asia upside is worth the risk despite trade conflict

    01. Aug 2018 Macro

    Too early to panic

    To make sense of trade tensions, we introduce two tests worth watching.

    02. Okt 2018 Investment Traffic Lights

    Investment Traffic Lights

    Our tactical and strategic view

    02. Okt 2018 CIO Flash

    Italian takeaways

    The haggling over Italy's budget continues. No wonder markets are nervous.

    28. Sep 2018 Chart of the week

    A closer look at the U.S. yield curve, nine years into the economic cycle

    Chart of the week

    13. Sep 2018 Chart of the week

    Volatility and the long shadows of Lehman Brothers

    Chart of the week

    07. Sep 2018 Chart of the week

    Fears in Rome

    Chart of the week

    12. Okt 2018 Letter to investors

    What does fall have in store?

    2018 better than expected so far. A good or bad signal for the cycle?

    12. Okt 2018 Fixed Income

    Credit, what else?

    We see selective opportunities in emerging markets.

    12. Okt 2018 Macro

    So far, so good.

    Conventional analysis paints a soothing picture of the global economic outlook.

    12. Okt 2018 Focus

    Casualties of trade conflicts

    How emerging markets became early victims of the simmering global trade war.

    12. Okt 2018 Performance

    Performance

    All performance at a glance

    02. Nov 2018 Investment Traffic Lights

    Investment Traffic Lights

    Our tactical and strategic view

    02. Nov 2018 Chart of the week

    Why the trend of rising U.S. yields might soften from here

    Chart of the week

    26. Okt 2018 Chart of the week

    U.S. company profits – too much of a good thing?

    Chart of the week

    25. Okt 2018 Equities

    U.S. equities under pressure

    The correction looks overdone, but we expect market volatility to persist.

    CIO View

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