Investor complacency, unsustainably low volatility and stretched equity market valuations might lead to market shocks, said the third-quarter update of Russell Investments’ Strategists' 2014 Global Outlook.
The Russell report compared current market conditions to the low-volatility/high-return environment that preceded the 2008 global financial crisis and cautioned that, although recession risks are low and a major market reversal seems unlikely, there is the potential for a spike in market volatility. Russell strategists see the decline in volatility across all asset classes, which the report cited at near all-time lows as measured by the CBOE Volatility index, as unsustainable for the long term.
The report noted a modest global preference for equities over fixed income and characterized the expected increase in volatility as an equity buying opportunity.
The 2.9% first-quarter contraction in the U.S. gross domestic product, the rise in U.S. core inflation and a potential inflation “scare” beyond the recent concurrent rise of the core U.S. consumer price index and the personal consumption expenditures deflator were cited as potential impacts on domestic equity market volatility. Geopolitical risks and concerns about China’s outlook were cited as potential emerging markets worries.
Russell analysts see European equities as “modestly expensive,” Japan’s valuation as “neutral,” and rate emerging markets as undervalued relative to developed market equities. The report said the U.S. has become marginally more expensive.
However, the report said growth should strengthen across the U.S. and Europe over the remainder of 2014 but the outlook in other markets was uncertain.
For the U.S. economy, strong economic growth in the first half of 2014, positive economic forecasts, and the expectation that the U.S. Federal Reserve's interest rate hikes will be held off until mid-2015 were perceived as positive business-cycle indicators.