BlueBay: Live. Die. Repeat

David Riley, head of Credit Strategy at BlueBay Asset Management, provides his view on how investors must learn and adapt to repeating episodes of market volatility

Markets appear to be stuck in a time loop rather like Bill Cage in the movie Edge of Tomorrow who dies in battle but subsequently awakens the morning of the preceding day only to repeat his death in battle again and again.

Cage – played by Tom Cruise – learns and adapts his strategy to eventually win the battle and save the world.

Investors must learn and adapt to a repeating market cycle of rising global growth fears, subsequent sell-off and rescue by ‘dovish’ central banks.

Mean reversion is a feature of these repeating episodes of market volatility – the greater the sell-off, the sharper the re-bound. But after such sharp relief rallies, markets are more likely to fall than rise over the following month underscoring the dangers of chasing market swings.

The chart below is a simple analogue centred on the lows for the S&P500 (indicated by day ‘0’ on the horizontal axis) and for global high yield credit spreads during October 2014, September 2015 and February 2016.

Each sell-off was associated with fears over global growth and the willingness and ability of central banks to provide further monetary stimulus. On each occasion, the market re-bound was fuelled by the anticipation and reality of central bank policy action.

The latest bout of market volatility is tracking quite closely the sell-off and rebound in September and October last year that contrary to the expectations of many, did not extend into a year-end ‘Santa rally’. It is also notable that each wide in credit spreads is wider and the post-recovery tights lower.

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