Will the Dog Days Bite Back?

Markets are quiet. Maybe too quiet.

It’s no surprise when markets take a break in August. Too many people are on the beach during the “dog days” of summer for important decisions to be made. Even so, August 2016 will go down as an exceptionally sleepy month.

Markets Barely Moved in August

Leading up to the meeting of central bankers in Jackson Hole last week, the S&P 500 Index went through 34 trading sessions without a 1% one-day move, up or down. It only broke 0.5% six times. That made it the least volatile 30 days in more than 20 years. Similarly, Bloomberg reports that the August trading range for the 10-year U.S. Treasury was the tightest for any month in a decade.

Moreover, investors appear to believe that these conditions will persist for some time. Not only has the VIX Index of one-month implied volatility in the S&P 500 been sinking since its spike after the Brexit vote, but according to Bank of America Merrill Lynch, there is now a record level of shorts in the VIX futures markets—bets that the index will fall even further.

Remarkably, this has happened before a Jackson Hole symposium in a year when central banks have been the only game in town. Janet Yellen’s speech there was one of only three she has made this year (the other two were in Philadelphia in June and New York in March). In 2015 she made 11 appearances and on average Fed chairs have given almost 20 addresses per year—so this ought to have been a hotly-anticipated event, especially as a number of Fed Presidents made notably hawkish noises leading up to it.

Is This Fatigue, or Complacency?

After the excitement of the global growth scare in January, the central-bank innovations of the spring, and the Brexit vote in June, perhaps markets needed some particularly “doggy” dog days to recover.

The more worrying conclusion is that they have grown complacent. One can understand why. Brexit turned out not to be the end of the world; U.S. jobs data is back on track; Europe’s economic data continues to improve; bond yields have fallen and corporate earnings have disappointed, but stocks keep climbing; rate hikes keep getting postponed; and opinion polls started to favor the more predictable U.S. Presidential candidate.

Low Volatility Can Heighten Market Vulnerability

But complacency is unwise—and not just because all of this could flip around by mid-September. In financial markets, complacency itself can store up danger, increasing vulnerability to unexpected changes in conditions.

A driver on a perfectly straight highway can be tempted to take his eyes off the road and put his foot on the gas, and investors often behave in a similar way. As “risk” appears to diminish, they add leverage or take bigger bets to use up their risk budgets. They become less inclined to hedge against downside losses, even as the premiums to do so get cheaper—hence the low level of the VIX. That makes for a harder crash when a tire blows out.

Market volatility reverts to its mean, but even taking this into account, periods of unusually low volatility have often preceded bouts of unusually high volatility. Volatility was low just before the dollar came off the gold standard in August 1971, for example; it was low at the beginning of 2007 just before the financial crisis began to unfold; and it was low early in 2011 before the Eurozone crisis erupted. Low volatility didn’t predict events like these, of course, but it created the vulnerability that explains some of the unusually high volatility when those events occurred.

When the Dog Days Are Over, Be Prepared

Given that a lot could happen this fall to reveal how complacent and vulnerable markets have become—from an inflation or rates shock to another twist in the U.S. elections or a geopolitical tire blow-out—investors should make sure their seatbelts are fastened.

The old proverb advises us to let sleeping dogs lie: prodding them awake can result in a nasty bite. Markets have slumbered deeply during the dog days of August. Investors should be prepared for when they rouse again.


Joseph V. Amato is President of Neuberger Berman Group LLC and Chief Investment Officer—Equities at Neuberger Berman. He is also a member of the firm’s Board of Directors and its Audit Committee. To learn more, see Mr. Amato's bio or visit www.nb.com.

In Case You Missed It

  • U.S. New Home Sales:  +12.4% to SAAR of 654,000 units in July
  • U.S. Existing Home Sales:  -3.2% to SAAR of 5.39 million units in July
  • U.S. Durable Goods Orders:  +4.4% in July (excluding transportation, durable goods orders increased 1.5%)
  • U.S. 2Q16 GDP (second estimate):  +1.1% annualized rate

What to Watch For

  • Monday 8/29:
    • U.S. Personal Income & Outlays
  • Tuesday 8/30:
    • Case-Shiller Home Prices
    • U.S. Consumer Confidence
  • Thursday 9/1:
    • Eurozone Purchasing Manager Index
    • ISM Manufacturing Index
  • Friday 9/2:
    • U.S. Employment Report

– Sonia Mukherji, Investment Strategy Group

Statistics on the Current State of the Market – as of August 26, 2016

Market Index WTD MTD YTD
Equity      
S&P 500 Index -0.7% 0.0% 7.7%
Russell 1000 Index -0.6% 0.0% 7.7%
Russell 1000 Growth Index -0.7% -0.3% 5.9%
Russell 1000 Value Index -0.6% 0.2% 9.6%
Russell 2000 Index 0.1% 1.6% 10.0%
MSCI World Index -0.3% 0.5% 5.8%
MSCI EAFE Index 0.2% 1.1% 1.9%
MSCI Emerging Markets Index -1.0% 3.4% 15.8%
STOXX Europe 600 0.7% 1.7% 0.0%
FTSE 100 Index -0.3% 2.5% 13.1%
TOPIX -0.6% -2.6% -15.8%
CSI 300 Index -1.7% 3.4% -9.4%
Fixed Income & Currency      
Citigroup 2-Year Treasury Index -0.1% -0.3% 1.0%
Citigroup 10-Year Treasury Index -0.4% -1.6% 6.8%
Barclays Municipal Bond Index 0.1% 0.1% 4.5%
Barclays US Aggregate Index -0.1% -0.4% 5.5%
Barclays Global Aggregate Index -0.1% 0.5% 10.3%
S&P/LSTA U.S. Leveraged Loan 100 Index 0.1% 0.5% 7.7%
BofA Merrill Lynch U.S. High Yield Index 0.3% 2.1% 14.5%
BofA Merrill Lynch Global High Yield Index 0.2% 2.1% 13.7%
JP Morgan EMBI Global Diversified Index 0.0% 1.9% 14.4%
JP Morgan GBI-EM Global Diversified Index -0.9% 2.0% 17.0%
U.S. Dollar per British Pounds 1.1% -0.5% -10.4%
U.S. Dollar per Euro -0.4% 0.9% 3.8%
U.S. Dollar per Japanese Yen -0.3% 2.0% 19.7%
Real & Alternative Assets      
Alerian MLP Index -1.4% -1.0% 14.2%
FTSE EPRA/NAREIT North America Index -0.4% -4.2% 13.1%
FTSE EPRA/NAREIT Global Index -0.4% -1.9% 12.1%
Bloomberg Commodity Index -1.4% 0.9% 8.4%
Gold (NYM $/ozt) Continuous Future -1.5% -2.3% 25.1%
Crude Oil (NYM $/bbl) Continuous Future -3.0% 14.5% 28.6%

Source: FactSet, Neuberger Berman LLC.

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