GLOBAL MARKETS: A NEW, MORE DIFFICULT STAGE / THE WALL STREET JOURNAL

Global Markets: A New, More Difficult Stage

The Italian bond panic is the latest in a series of upsets to challenge investors who had got used to markets insulated from risk

By Richard Barley



SPOT THE DIFFERENCE
One-day change in MSCI All-Country World Index

Source: FactSet

If last year in markets was all about strong returns, this year is about rising risks: a brewing trade war, renewed political turmoil and concerns about growth. The difference is that central-bank policy that helped insulate markets from risk is changing. Investors are increasingly looking after themselves.

Last week’s wild swings in Italian bonds are just the latest in a series of shocks that have made 2017’s smooth market ride a distant memory. Surging Treasury yields, equity-market volatility and trouble in Argentina and Turkey are all part of the same picture. These have been episodes where the moves in financial-market prices have become news themselves—something that hardly happened at all in 2017, and a sign of their sheer scale.

In financial jargon, risk premia are being repriced. In everyday terms, investors are quicker to sell and are starting to pay up for protection in an environment where central banks, whose policies have pushed them to take risk, no longer have their backs.

In 2017, the biggest one-day decline for the MSCI All-Country World index of developed- and emerging-market stocks was 1.4%, and only on two days did it fall by 1% or more. This year already the biggest drop is 2.9%, and 11 days have seen declines of more than 1%.

Meanwhile, the gap between investment-grade corporate-bond yields and yields on safer government bonds in both the U.S. and Europe has been widening steadily since early February, a further sign that investors are demanding extra compensation for taking risk.


MOVING OUT
Yield spread of investment-grade corporate bonds over government bonds

Source: ICE BofAML indexes via FactSet

The VIX index, a measure of expected U.S. stock-market volatility, has also averaged 16.7 this year, higher than any of the peaks recorded in 2017, when the full-year average was 11.1.


RISK RESET
CBOE Volatility Index

Source: WSJ Market Data

With the global economy solid and inflation rising, the days of central banks doing “whatever it takes” are in the past. The Federal Reserve is raising rates while there is no sign of the European Central Bank further loosening policy. Previously, bad news came with the silver lining of a potential policy response, but now good news brings the prospect that policy will be tightened. Higher rates for U.S. Treasurys in particular create competition for riskier bonds and stocks.

Swings in Italian bonds are the latest in a series of shocks. Photo: daniel dal zennaro/epa-efe/rex/s/EPA/Shutterstock 


The low-volatility environment made it more profitable to invest without paying for insurance against downswings in markets, notes UBS . That exaggerates the reaction to events like last week’s Italian saga or to signs that the U.S. will enter a deeper trade war with its allies and rivals.

Morgan Stanley ’s strategists call the change “the end of easy” for markets. That doesn’t spell the end of returns, as long as global growth holds up. But it will require investors to be more nimble, and, after a long period when much went right, think more carefully about what might go wrong.