LITTLE ROOM FOR ERROR
There have been signs that the markets were set to break through the summer doldrums courtesy of the numerous geopolitical trouble spots that have suddenly flared up. However, in the all too familiar pattern that has emerged this year, investors have again become sanguine in their view of risk, putting faith in the central bank puts that have been extended around the globe. While we had the first 1% move in the S&P since the spring, and a legitimate mini sell-off in the HY markets, volatility remains muted for most asset classes. Even the weakness in stocks following the Malaysian Air tragedy has completely reversed and the S&P closed at another all-time record yesterday. While volatilities have been generally stable over the past few months (versus further compression), we, nonetheless, remain at levels that are less than half of where we were last year from a volatility perspective. However, there have been a few instances where we have seen some percolating volatility, such as in high yield and periphery debt. We view this as indicative of the rich valuations that exist in many asset classes, which is pushing investors to shoot first and ask questions later when risk concerns flare. We, therefore, find further spread compression challenging in this tight valuation environment, which includes the continuation of unresolved geopolitical risks.