GeopoliticaltensionsandVolatilityclusters

Yesterday we had written that think about every phenomenon purely in monetary terms is a mistake as there are other geo-political considerations that need to be taken into account. The argument was given in the context of the US Dollar reserve status, outlining that its financial supremacy also stems from the military heft which the US carries around the world. Little did we know that during the day the Indian markets would be besieged by the geo-political news from the Sino Indian border. All three markets including equity, bonds and stocks were impacted in equal measure following the news of escalated tensions and fatalities at the northern border.

Across the world, though, the markets had a good day. The Dow Jones jumped up by 2% following the news about the possible 1 trn USD stimulus plan and the retail sales data which was beyond expectation, jumping close to 17% mom in May. The good retail sales signified the gradual opening of the economy and the pent up demand of the shut down months. During the day the Fed Chief Jerome Powell said that while recent signs of improvement in employment and a rise in retail sales are encouraging, the damage inflicted by the shutdowns is very deep, especially on the employment front. Referring to the 25 million people who have been displaced from the workforce, he said that it is still a long road ahead to get those people back to work. The Fed Chief again renewed his call for law makers to provide more fiscal support, he said that the Fed “could lend but not spend, unlike congress”. Our readers would identify that the last statement hides one critical fact about the Fed’s prowess - that it is the “one which will lend for that spend”.

As the markets across the world (including equities, bonds, currency, oil and gold) remain volatile, with increased variance across the mean in both directions, we can try to describe it with a phenomenon called volatility clustering. The phenomenon was first discovered by IBM scientist Benoit Mandelbrot in 1960’s when he was studying long term time series data of cotton prices. While describing the phenomenon in his book Misinformation in the Markets, Mandelbrot writes that if we study the time series charts of any asset class we can discern periods where the absolute price variations are very high as compared to other periods. This observation flies in the face of the belief that prices are random and have no memory. Simply put the observation that large changes tend to be followed by large changes of either sign and small changes tend to be followed by small changes, has an implication for investors who can use this information to resize their bets and hedges accordingly.

As the Indian assets open on a calm note, the sobering facts remain the same - that no solution for either the border skirmishes or the virus has been discovered. It looks likely that we are not yet out of the high volatility cluster.