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We started the year publishing a paper welcoming 2020, and tail risk we’ve seen before. We mentioned that the combination of low relative return dispersion and soaring correlations of stock returns from the prior year engendered increasing overconfidence and groupthink, resulting in an unjustified sense of security with few places to hide when volatility spiked.


F1 Dispersion vs Correlation of Returns Across Equity Indexes

 

And, that’s where we find ourselves today given the COVID-19 pandemic, which was the catalyst for a fragile market state that was showing signs of strain. As the global economic engine is coming to a halt, we can justifiably characterize the last couple of months as horrific days for equities.

 

F2 Year-to-Date Equity Market Returns

 

Volatility Spikes

Global equity markets quickly went from new highs to slipping into correction and then bear market territory. As concerns over the novel coronavirus and its economic impact deepened, volatility rose sharply as equity markets plummeted.

Our data suggest that liquidity in equity markets has generally been good, but with conflicting factors in play: elevated volumes and widening spreads. According to our data and our brokers, volumes in the market have been 25-100% higher. However, bid-ask spreads have widened between 2x and 5x their normal levels as volatility spiked over the same period. In fact, volatility over a 20-trading-day period reached a 30-year high for the S&P 500, exceeding even the peak of the Global Financial Crisis.

 

F3 - Rolling 20-Day-Trading Standard Deviation

Capital Concentration

As we’ve been noting since 2018, capital concentration in the U.S. and non-U.S. markets remains at opposite sides of the spectrum. This represents a deviation from recent decades where they tended to move more in sync, and is a sign of additional strain in developed markets.

 

F4 Capital Concentration

 

Index Efficiency

A recent shift in index efficiency in U.S. markets over the past year, from near the historical median to the bottom quintile, may indicate further degradation of investors’ sentiment. Looking ahead, the substantial drawdown over the past couple of months is likely to impair sentiment for a considerable period of time. This raises many challenges, which are best overcome by patience and keeping a long-term perspective. 

 

F5 Index Efficiency

 

See For Yourself

In addition to the metrics we’ve just discussed, we’ve also seen dispersion of returns, a measure of cross-sectional volatility among stocks, increase dramatically from the historically low levels at the start of the year. This has occurred across nearly all major indexes we track. Check out the Intech Equity Market Stress Monitor® for an interactive look at how this and other indicators have moved over time.

 

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