Volatile volatility undermines growth and heightens financial instability.
Investors would be well advised to remember these five points:
- With the U.S. as the only non-crisis country willing to tolerate the appreciation of its currency, there is little in the short-term that is likely to counter the relentless march of a stronger dollar. That means the euro won’t be the only currency to experience a notable depreciation. This phenomenon will be widely shared across the foreign exchange markets.
- The currency moves are likely to overshoot — particularly when it comes to emerging markets — going well beyond what is warranted by fundamentals. These excessive movements are likely to drag down other emerging market segments, such as local rates, to levels that will eventually offer compelling value for longer-term investors with an institutional appetite for volatility.
- Despite the record levels in some maturities, short-term forces will continue to favor a widening yield differential between the U.S. and Germany. But there is an arbitragable limit to this gap, and we are getting closer to it.
- Heightened equity market volatility accentuates the attractiveness of a stock-selection approach that emphasizes not just solid corporate fundamentals but also high cash generation. In the meantime, the generalized market beta trade — investments that rely on the returns of the market as a whole — will be challenged.
- For those who insist on market beta, Europe offers more compelling valuations than the U.S., provided investors can hedge the currency risk in a cost-effective manner.