History favours being bullish on US equities – but take care History favours being bullish on US equities – but take care History favours being bullish on US equities – but take care

History favours being bullish on US equities – but take care

Equities 9 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  The Fed's latest rate hike seems ill-judged but what does this mean for equities? We've crunched the numbers, found huge variance and concluded that great caution is warranted.

The VIX Index remains elevated at around 28.6 and US equities are down 0.5% before the cash market opens. US equities are down 16% from the peak in September and the smell of panic is spreading. The big discussion is whether the Fed made a policy mistake two days ago. The SaxoStrats team is of the view that it was most likely a policy mistake. The rate hike would have been justifiable, mostly to send a signal that the Fed is independent, but maintaining quantitative tightening on autopilot and putting too much weight on lagging economic data series were the two things that scared investors. As it is, the bleeding continues and frighteningly into a thin liquidity holiday period. So what can we expect from here? Well we have been crunching the numbers and here are our answers to confused and panicking investors.

It can get much worse

For analysis we broke daily VIX Index levels into deciles since 2 January 1990. We then isolated all the historic dates were the VIX Index was at the same level as the current decile. With the VIX Index at 28.6 it is currently in the ninth decile [24.1 – 28.6]. We then extracted the future returns 63 trading days into the future from that day. Aggregating all these returns provide us with historical sample returns. In order to compute the distribution of future paths we bootstrap* (with replacement) from the historical sample returns series future paths 63 trading days into the future. In total we simulate 50,000 paths.

The chart below shows the median (dark blue line) of these 50,000 paths and the ribbon spans the worst-to-best cumulative return in % at any given future time. It is clear that the potential outcome 3-month into the future from our current level in the S&P 500 is enormous. In the best possible scenario based on historical data we could be up 60% or down 39% (roughly the same log return).

Source: Bloomberg, Saxo Bank

The density of the terminal values (cumulative return in % after 63 trading days) are as shown in the chart below. The distribution has a positive skew which should not be a big surprise.

Source: Bloomberg, Saxo Bank
The quantiles at 5%-point steps are shown below. They show that there is indeed a 5% probability that the S&P 500 could fall another 16% in the next three months and 5% probability that the index will be 21% higher. The point is that investors should recognise the immense variance in outcomes over the next three months. There is a 10% probability that we are in for a massive roller-coaster journey.
Source: Bloomberg, Saxo Bank
To illuminate the 5% cut-off in the tails we have drawn the levels on the S&P 500 futures chart (continuous). It looks scary but that’s the reality that everyone has to accept. To give some perspective, the equity options market for S&P 500 closed yesterday with the 15 March 2019 C2990 option at $2.95 and the 15 March 2019 P2075 at $18.50.
S&P 500E-mini futures (continuous) on weekly observations.                                                     Source: Bloomberg

As we highlighted in our live presentation two days ago we would favour being tactically long equities (global) if the Fed could deliver, which they didn’t, and China would announce another round of stimulus. The Chinese government may soon come to the rescue as the CSI 300 Index futures broke down today to new lows for the year and cycle, adding further pressure. The stabilisation phase in global equities could come soon from China and then if things go smoothly Fed governors will increase their dovish language in speeches during January.

Even when equity markets are quiet things can go wrong

We believe few investors understand the actual risks they are taking in equities. 2017 was the ultimate year of compressed volatility in equities. In these times, and especially a long bull market, investors can be lulled to sleep. But again running 50,000 simulations on historical returns from a starting point with very low VIX Index (first decile [9.1 – 11.9]) we get a large range in terminal cumulative returns after 63 trading days. When things are very calm investors should realise that there is a 5% probability that equities will decline by more than 6% (worst case 18.7%). In other words expect the unexpected when trading or investing in equities.

Source: Bloomberg, Saxo Bank                                                                                                                                                                 * Bootstrapping samples from realiseddata, whereas Monte Carlo simulation generates possible outcomes by samplingfrom a theoretical distribution

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000

Contact Saxo

Select region


The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.