Volatility

It's important to preface this week's blog with the adage that it's always best to be aware of people offering simple answers to complex problems. This week's volatility in global markets has been triggered by a vast array of different factors, all acting in tandem to create a set of unique market conditions. We have decided to pick two primary ones you may have heard paraphrased in the news and unpack them further. We will also address the issue of the importance of the much-demonised volatility in the market to generate opportunity and outline where our asset class sits on that spectrum to service perhaps a different need in terms of balanced risk.

The primary issue is the Japanese Yen vs the U.S. Dollar. For the previous 30 years, Japan has levied 0% interest on its currency, allowing global investors to borrow Yen at no cost and invest it elsewhere in the world for the highest yield they can find. This transaction is known in the industry as a 'Carry Trade'; ultimately, an investor could borrow Yen at zero percent, invest it in government-backed treasuries in a different country or the equivalency, repay it over time, and keep the difference. As time went on, human nature kicked in; as we have mentioned before in this blog, it's almost our instinct to believe what is happening now will happen forever, and after 30 years, there was a strong precedent for that.

So, what happens? The same thing that always happens: the risk curve went up, and the Yen was used for more and more risk speculation, growth stocks in the NASDAQ, and higher volatility plays. Then, to stop the Yens value slide against the dollar, the Bank of Japan raised interest rates by 0.25% in a move that signalled to the market that this could be the beginning of a hawkish summer. This move on the Japanese domestic front instantly caused problems, as a generation of Japanese businesses has been built on the perks of a low-rate environment. Still, regarding the global macro picture, all traders and banks performing these trades must at least consider beginning to unwind their positions if rates increase further and their margins disappear.

Reportedly, about four trillion USD could be unwound to return these funds to Japan, a lot of it in capital markets and growth stocks, as they have been the best-performing trend assets in recent years. The problem with these crowded swaps markets is one profitable idea leads to a crowded trough, so nobody really knows how many counterparties are crowded around and feeding off the same trade, which means when it unravels, it can have a compounding effect across all interconnected markets. The system acts on confidence, so the prospect of that alone would be enough for selloffs to begin. However, further global macro factors have also been a problem this week to create this situation; as referenced earlier, complex problems do not have simple causes or solutions.

The second impactful issue this week on the markets has been central bank policy driven. The expression "priced in" is one that often gets flung about in the market, as if the market is something that has a finite correct or incorrect pricing when it’s a constantly evolving entity. Typically, what this really means is players who are attempting to get ahead of the crowd have already made their moves; the basic psychology of capital markets is you make the most money being right when everyone else is wrong, but at a minimum, you have to at least try and not be the only one wrong. Any narrative of rate cuts coming at a three or six-month out juncture is usually followed by a lurch into risk assets for this very reason, chasing yield. Weak U.S jobs data, concern over trade relations with China, and recession fears do point towards the likelihood of a September rate cut in the U.S, but the move into risk assets may have started way too soon, and the unwinding of some of these trades, again compounds the extreme volatility we see across the market, albeit at the point of writing this, a nominal recovery appears to be underway.

So, what are we trying to say here? It's important to point out that volatility is the lifeblood of capital markets; it's where the money is made in trading to the extent that high volatility, as measured, for instance, by the VIX index in the U.S. measuring 30-day expected volatility, is seen as positive sentiment. For instance, when this measurement was flattened out after the 2008 crisis by regulation, global profits in Investment Banking were significantly eroded to the extent many traders left the market. It's also important to remember that the short-term volatility investors fear is typically flattened out over broader time horizons; investing in the market in a diversified way, i.e. a low-cost S&P index, is essentially betting on the success of the global economy, so the greater the time horizon, the better odds you get.

With the P2P asset class, it would be remiss of us to suggest that we aren't exposed to massive movements in financial markets that affect the performance of entire economies; when it's raining, everyone gets wet, but there are those with the umbrellas of diversification to shield themselves from the worst of it. As part of a balanced portfolio, if you are looking for fixed returns over what we would consider a mid-term time horizon, years rather than decades, volatility such as what we have seen over the last week may very well not suit your individual requirements in equities alone. In a blog that's packed with old adages this week, 'time in the market often beats timing the market', but nobody knows in equities what that successful timeframe will be. If you want a return comparable to traditional fixed income and want to control what that "time in the market" looks like, the P2P asset class offers those solutions and returns with the same tax-efficient compounding effect on multi-year diversified investments.

Invest & Fund has returned over £200 million of capital and interest to lenders with zero losses, showing the rigour that governs our business.

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