The Trump “bump” is now officially the Trump Dump, as investors flee the market. That’s how it goes when you take credit for everything good in the economy and the stock market, and then things turn.
All of the policy confusion about trade wars, real wars, and economic policy has been laid bare and it ain’t a pretty sight. The animal spirits let loose on the markets only two years ago have come back to bite investors, who are being whipsawed by all of the confusion coming out of the administration over trade and economic policies. As if that wasn’t enough, impeachment is now a real possibility given the recent revelations about Trump’s involvement with Russia and the Democratic control of Congress.
Suddenly, nearly every risk scenario we have highlighted over the past two years is happening, all at the once. This means that that record low correlation, low volatility year in 2017 will not help you in any risk analysis for the current environment. We are now experiencing high volatility and high correlation, with nearly every asset class showing losses for the year. In essence, 2018 turned out to be everything that 2017 wasn’t, in the worst possible way.
What does this mean for risk management? Forget about the good old days of 2017, that data set will prove as useless as 2016 was for the financial crisis. You need to start thinking about the impact of indiscriminate selling from ETFs forced to liquidate positions as redemptions accelerate. How will this effect the rebalancing of “low volatility” funds? It won’t be pretty.
This is a time when risk managers need to carefully review all of the underlying market data and risk model assumptions to avoid misinterpretations of the risk signals at such a critical point.
- Have you had more VaR exceptions than expected recently?
- Are the exceptions of a much larger magnitude?
- Is this due to individual securities losses, the correlation of the portfolio or both?
- What has happened to the return distributions of the risk scenarios in the past 3 months?
- What hedges would be effective in this environment?
It’s time to earn your keep. You have your work cut out for you.