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OPINION

Quite a quiet quarter

Quite a quiet quarter
April 6, 2017
Quite a quiet quarter

All FTSE indices have rallied to new record highs, continuing their winning streak for a third or fourth consecutive quarter. Volumes have dropped along the way to roughly half of their peak and observed volatility is among the lowest since these indices were introduced.

 

 

Not surprising then that the cost of insuring against a market fall is also about as low as it has ever been. This is not a winning combination; it is known as divergence between price action and secondary indicators. In the process, the UK stock market has become as overbought as it was in 2007 and small signs of instability have appeared over the past month, tiny potential head-and-shoulders patterns appearing in the daily charts. Therefore we would advise a defensive stance and urge readers to actively consider cutting positions and losses should the need arise.

Gilt yields, which are set by the market and not by the Bank of England, are not as low as they were last year - when they were at all-time record lows - but are currently rethinking the possibility of rate rises and higher inflation. They have reversed half the back-up in interest rates that we saw from Q3 2016's trough, keeping the long-term and secular trend to lower rates intact.

 

 

This quarter's high, because of subsequent price action, is probably yet another interim high. Therefore there is still a chance that yields might even move to new lows - and higher gilt prices - later this year or next year.

 

 

After its pummelling since the vote to leave the European Union, the pound has been on a sounder footing. Although recovering only fractionally against major currencies, at least it's not in freefall. In other words, there is currently no momentum to further sterling weakness. Observed volatility has halved since last summer's peak, and is less than a quarter of the peaks it reached in 1985, 1992 and 2008. This has of course provided a drag on implied volatility of both calls and puts. On the Bank of England's trade-weighted basket it remains too close for comfort to the record low. Great care must be taken not to rock this boat again. Let's hope the authorities take this on board.

 

 

Finally another asset class of interest to investors: gold, here priced as US dollars per ounce, the international convention. The bear market since its record high in 2011 is intact, but momentum is no longer negative - another market that is diverging. The futures market has seen open interest drop by a third, suggesting investors are less positive towards this asset class, and both silver and platinum have similar charts and dynamics. Therefore we will favour a generally sluggish market with the risk of further limited price falls - although it might provide a currency hedge should the pound weaken further.

Charts for this piece: FTSE 100, 30-year gilt yield, GBP/USD, gold.