Once again this quarter, the primary macroeconomic story affecting nearly every asset class has been the liquidity provided by central banks around the globe. From March 1st to May 22nd, just the Federal Reserve’s balance sheet alone increased by $285 billion. Many market analysts, such as Bianco Research in the figure below, have concluded that stocks’ positive returns in 2013 (and in recent years as well) have been greatly influenced by this liquidity.
Meaningful fundamental earnings data did not seem to have a significant impact on stock market volatility or direction in the first half of 2013. Q1 earnings reports and Q2 earnings pre-announcements both indicated that S&P 500 companies are generally struggling to grow revenues. According to Thomson Reuters, as of May 1st, 43% of S&P 500 companies had reported beating analysts’ Q1 revenue expectations, much less than the typical 63%. In addition, as of June 28th, the Q2 ratio of negative to positive earnings pre-announcements was 6.5, which is the worst pre-announcement ratio since Q1 of 2001. Meanwhile, U.S. equity market margin debt rose in late Q1 to levels equal to those reached at the previous market peak in mid-2007, meaning that a significant amount of leverage is contributing to stock valuations.
Despite this potentially dangerous combination of negative news and high leverage, the events that really moved stocks the most in H1 2013 were FOMC minutes and public statements by the Federal Reserve Chairman. In the two weeks preceding the Feb 20th release, the standard deviation of daily S&P 500 returns was 0.5%; in the week following the release, it rose to 1.3%. This realized volatility vanished as quickly as it appeared – in the ensuing two weeks, it fell again to 0.3%. The same pattern occurred again following the April 10th release.
In this light, the past two quarters (and perhaps more) of strong stock market performance could be viewed as a temporary repeal of conventional market forces.Because of the brief duration and limited severity of realized volatility events over the past 12 months, there have been few episodes of market stress that our strategies are designed to both protect against and profit from.Nonetheless, our strategies have continued to perform as designed, and, we believe, continue to serve as valuable protection against the downside risks that equity markets face.