(Source: Momentum Global Investment Management)
30 April 2020
Source: Bloomberg & Momentum Global Investment Management
What this chart shows
This chart shows what we call the “Turbulence Index”, a proprietary reference index we use to measure the level of abnormality in market behaviour. It uses a variety of asset class returns to estimate to what extent market moves have been turbulent, with respect to their size and direction, when compared to history. For instance, in a “normal” environment, high yield bonds tend to show positive correlation and higher volatility compared with investment grade bonds, or equities often display negative correlation and much higher volatility compared with government bonds. However, in an “abnormal” environment, perhaps because of an external shock, one or many of the asset classes may not abide by their typical characteristics but deliver returns that are outsized and/or break the usual correlation patterns with other asset classes. For instance, an “abnormal” week could be one where bond yields have fallen dramatically but equities have not moved at all, or one where investment grade bonds gain substantially more than high yield bonds, or one where developed market equities rally while emerging market equities drop. The chart above shows that the ongoing crisis has, so far, not only unravelled much faster than the global financial crisis but it has also proven to be a more turbulent period.
Why this chart is relevant
Investors have been looking at past financial, or economic, crises (the GFC in particular) as a guide to estimate characteristics of the current one. The main concerns are its depth, overall duration, location of the bottom and potential further declines in asset prices. While this comparison can be informative, one must not disregard the differences between each of them, one being the much higher turbulence experienced in the past two months. Not only did all asset classes deliver extreme returns (mostly negative) in large excess relative to their historical “normal” ranges, but most correlation patterns broke as investors sought to de-risk their portfolios, raising as much cash as possible at whatever price available and causing a brutal liquidity shortage. This abnormality, despite being common during crises and market crashes, has never looked as pronounced (so far), not even in the depth of the global financial crisis.