While there is more upside to equities in 2017, market risk will increase substantially because of a strong USD and higher rates, says Marko Kolanovic, Global Head of Macro, Derivative and Quantitative Strategies at J.P. Morgan Securities.
Kolanovic points out that there is a record divergence between market volatility (as measured by the VIX) and political uncertainty (as measured by the Global Economic Policy Uncertainty (EPU) index), whereby the VIX has been underperforming the EPU since 2011 (see Chart). He argues that this difference probably exists because of aggressive monetary accommodation.
Kolanovic thinks that once monetary accommodation is removed this will all change. Bond buying programs will no longer be there to keep yields low and put upward pressure on asset prices and, because he thinks that geopolitical risk is more likely to rise than fall (e.g. Brexit, elections in France and Germany, etc), Kolanovic expects market risk will rise substantially in order to catch up with geopolitical risk.
(Chart source: JPM QDS Research; Bloomberg; “An Index of Global Economic Policy Uncertainty” by Steven J. Davis at www.PolicyUncertainty.com)