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Don’t confuse inactivity in the market for investor euphoria, Nomura warns


Global stocks are trading near all-time highs, driven by a rebound in commodity prices as oil prices rose above the $50 a barrel mark after a fall in U.S. inventories and a bigger-than-expected cut in Saudi Arabia's supplies to Asia helped tighten the market.

The MSCI developed markets index is edging close to all-time highs as investors trade on low levels of volatility. Earlier this week, the CBOE volatility index fell to its lowest level since 1993.

While this is interpreted by many as a measure of positive times ahead of the market, a number of analysts have warned that this may not last very long as volatility does not stay at low levels for prolonged periods of time.

A trader works on the floor of the New York Stock Exchange (NYSE) in New York.
Michael Nagle | Bloomberg | Getty Images

Bilal Hafeez, head of G10 FX strategy at Nomura, warns that the current level of inactivity in the market should not be confused for investor euphoria.

"It seems uncertainty surrounding the Trump administration's policies and French elections have resulted in cautious investor positioning and even inactivity," Hafeez writes in his latest research note, adding that the recent decline in commodity prices, seemingly driven by a slowing China, has also been remarkably contained.

Hafeez further explained that even though risk measures are at low levels, this does imply investor euphoria.

"Instead, external triggers will be needed to trigger a bout of risk aversion. An obvious one would be policy action such as an overly hawkish Fed or a growth-insensitive PBoC (People's Bank of China). With the former, the market is already almost fully pricing a hike in June, and so the Fed would need to talk up later hikes, which we think is unlikely in the run-up to the June meeting.

With the latter, we think the Chinese authorities would be reluctant to induce a sharp slowdown ahead of the 5 yearly National Congress to be held later this year."

The volatility index was seen to hit single digit lows after centrist Emmanuel Macron won the French Presidential election over the weekend. Global stocks got a boost but safe-haven currencies such as the yen and the Swiss franc suffered but analysts warned against taking huge risks in this quiet market.

"It was a case of buy the rumour and sell the fact in the markets," Mihir Kapadia, CEO and Founder of Sun Global Investments, told CNBC via email. "Markets had run up in anticipation of a Macron victory but investors sold into it and French (and European) stocks and the Euro were unable to maintain their momentum. Therefore overall, a slightly disappointing start to the new week following the positive outcome of the French election."

On Monday, the Vix index or the Chicago Board Options Exchange Volatility Index, a measurement of expected short-term volatility in the S&P 500, closed at 9.77, the lowest point since December of 1993. The index is still down at very low levels of 10.33.

"'Non-risk' events such as a stronger euro or even stronger equity markets could see volatility and other risk measures rise. That remains our base case. Therefore, we would be comfortable taking a nuanced approach to the risk environment," Hafeez said.

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