In the Eye of the Storm

by Eric Knutzen, CIO, Multi-Asset Class, Neuberger Berman

Take care not to mistake calm markets for fair weather.

By the time you read this note, we will know whether or not Hurricane Irma made landfall in Florida. The state declared an emergency almost a week ago. Since then the storm has crashed through the Caribbean leaving devastation in its wake. The U.S., for its part, has been bracing for impact even as it deals with the flood damage of Hurricane Harvey.

Our thoughts are with the victims of these storms, and we wish the best for those who remain in Irma’s path.

Financial Storms Suppressed

If Irma has hit Florida as at least a Category 4 storm, it will have been the first since Hurricane Wilma 12 years ago. Coming just a week or so after Harvey, this would be the first time on record that two storms of this magnitude have struck in the U.S. in a single season. But despite appearances, when it comes to the weather, longer periods of calm do not lead to a higher likelihood of more terrible storms in the future.

Financial markets can be different. An extended period of lower volatility and higher asset values can lead to greater risk-taking and increased leverage in pursuit of returns, making the potential storm much bigger should investors try to retreat.

Moreover, while humans can do little to suppress tropical storms, we can and do act to suppress financial storms. The past decade of extraordinary central bank interventions is a possible potent example of a financial storm deferred, and politicians are masters at cobbling together quick fixes for long-term, structural challenges.

Kicking the Can

Ironically, it was Hurricane Harvey that provided President Donald Trump with the cover for a quick fix for the impending U.S. debt ceiling and budget reconciliation tempests. He struck a deal with the Democrats to postpone these difficult decisions until mid-December to free up disaster-relief funds in the moment. Republicans in Congress who wanted to use the deadline to press for fiscal and structural reforms were not happy.

Treasury bills maturing in October, whose yields had climbed to September 2008 levels, rallied hard, and those maturing in December sold off. Amid all of this, however, long-dated bonds barely moved. After all, U.S. and global economic fundamentals remain slow but steady—the “Goldilocks” scenario—and it is true that all of our monetary policy and political can-kicking can help to extend this expansionist stage of the business cycle.

Staying Weatherproof

But investors should not mistake the current market calm for genuine fair weather. It could be the eye of a storm.

Things can stay calm if we keep moving with the hurricane swirling around us, but there are many things we might stumble over: a tactical error over Korea, or a decision by the Federal Reserve as it attempts to normalize monetary policy while recycling many of its senior personnel, or from a U.S. president piling more and more onto the legislative agenda of a divided Congress, alienating his own party and failing to push the debt ceiling pinch point beyond the next session.

None of these exogenous risks have blown markets off course yet, and, as with weather systems, buying time can allow their pent-up energy to dissipate. In the financial system, however, time can equally allow a Category 3 storm to ramp up to a Category 5.

As such, investors who recognize that we may be in the eye of a storm should consider staying their course when they hear the winds around them: Remain diversified. Maintain exposure to broad markets. But also, crucially, consider other sources of return, such as uncorrelated hedged strategies, alternative risk premia or relative value opportunities that may be less likely to leave portfolios overexposed to a sudden change in the weather—fair wind or foul.

 

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Investing entails risks, including possible loss of principal. Investments in hedge funds and private equity are speculative and involve a higher degree of risk than more traditional investments. Investments in hedge funds and private equity are intended for sophisticated investors only. Indexes are unmanaged and are not available for direct investment. Past performance is no guarantee of future results.
The views expressed herein include those of the Neuberger Berman Multi-Asset Class (MAC) team and Neuberger Berman’s Asset Allocation Committee. The Asset Allocation Committee is comprised of professionals across multiple disciplines, including equity and fixed income strategists and portfolio managers. The Asset Allocation Committee reviews and sets long-term asset allocation models, establishes preferred near-term tactical asset class allocations and, upon request, reviews asset allocations for large diversified mandates. The views of the MAC team or the Asset Allocation Committee may not reflect the views of the firm as a whole and Neuberger Berman advisers and portfolio managers may take contrary positions to the views of the MAC team or the Asset Allocation Committee. The MAC team and the Asset Allocation Committee views do not constitute a prediction or projection of future events or future market behavior. This material may include estimates, outlooks, projections and other “forward-looking statements.” Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed.
This material is being issued on a limited basis through various global subsidiaries and affiliates of Neuberger Berman Group LLC. Please visit www.nb.com/disclosure-global-communications for the specific entities and jurisdictional limitations and restrictions.
The “Neuberger Berman” name and logo are registered service marks of Neuberger Berman Group LLC.

 

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