The Return of Market Instability
The Chicago Board Options Exchange Volatility Index® (or VIX),1 a common measure of market instability, spiked dramatically in the month of February. All kinds of macro/geopolitical factors led to this change of environment. Also of note, markets had been unusually quiet for the better part of two years, with the exception of the spike in volatility caused by Brexit in the summer of 2016. Other than that, perhaps, it had been too quiet for too long.
Early in the year, headlines were consumed with news of North Korea testing inter-continental ballistic missiles that could have the capacity to deliver nuclear warheads. As the year progressed, confidence in the economic recovery in Europe came into question as well. Then came political instability in Italy as a result of an election that bore no outright winner, leading, after months of negotiations, to the formation of a government that is a bit EU unfriendly. The rhetoric coming out of the new government’s formation spooked the European markets and the euro, which severely negatively impacted prices of financial service companies with Italian exposure.
Despite the rhetoric out of the politicians in Italy, we don’t believe the sharp fall in share prices of high-quality financials is at all warranted or matched by a similar decline in business value. Having witnessed 66 different governments since 1945, Italy has never been known for political stability. As happens often during market instability, an exploitable value gap can be created by any fall in price that is inconsistent with changes in business value.
Of Trade Disputes, Disagreements and “Wars”
Another factor negatively impacting short-term international equity performance has been the threat by the United States to use tariffs and other barriers to correct what the Trump administration believes to be a global trade system that is biased against the US.
These threats and, to some degree, actual implementation of tariffs on certain metals have caused retaliation by other countries, thereby triggering a disruption of global trade. I have mentioned in the past and truly believe that the restriction of goods, services and capital from freely moving across sovereign states is detrimental to global economic growth. The purpose of the US’s confrontational approach is to “level the trade playing field” and hopefully this will be the outcome in the end. But if this objective is not reached, or if a global trade war escalates and persists, growth is likely to be negatively impacted as are the earnings of many of the companies and their investors.
One of the sectors feeling the brunt of the fall in prices has been the European auto sector. Despite some positive factors, such as recent weakness in the euro and lower Chinese tariffs on cars imported from Europe, the recent threat of tariffs on German cars being exported to the US and Chinese tariff threats for German-badged cars made in the US but exported to China have affected the share prices of European automakers. Additionally, the threat of tariffs on US agriculture products has hurt agriculture equipment makers. Clearly, if tariffs are implemented and stay for the long term, these companies will decline in intrinsic value. However, keep in mind that free trade is not “zero sum,” and it is difficult to imagine that parties will be unable to find a way to iron out differences, as it will be beneficial to all involved to do so.
Finding International Equity Opportunities
Despite all of the geopolitical uncertainty, I am quite confident that this environment is providing opportunity for investors in international equity. I believe Italy is unlikely to leave the Eurozone (and the euro currency union) given its high level of national debt and what an exit would do to Italy’s interest rates and payments. Though it is possible for a trade war to persist, I feel it is unlikely given that national self-interest of all involved would actually be harmed by this event.
Share price movements are not always positive, but volatile periods and short-term share price weakness can mean opportunities for investors, particularly when changes in price do not match changes in value.
1 The CBOE Volatility Index (the VIX) measures the implied volatility of the S&P 500® Index. The VIX is quoted in percentage points and represents the expected range of movement in the S&P 500 index over the next year. For example, if the VIX is 15, this represents an expected annualized change of less than 15%, up or down.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
All investing involves risk, including the risk of loss. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. The ability of an actively managed investment to achieve its objectives will depend on the effectiveness of the portfolio manager.