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Digital Subscriptions > The Hedge Fund Journal > Issue 128 – Nov | Dec 2017 > Volatility and Uncertainty

Volatility and Uncertainty

The drivers and the implications

COMMENTARY

Volatility in equities, bonds, and other asset classes remained at very low levels compared to historical norms in 2017, as measured by the standard deviation of daily market price movements. Yet, at the same time, uncertainty was exceptionally high concerning a wide-ranging array of potentially market-moving events which were often in the daily news and getting considerable attention. The co-existence of relatively low volatility and high uncertainty presented an interesting conundrum.

The list of potential volatility-inducing questions was quite long during the year 2017. Would the future course of fiscal policy in the US involve a big corporate tax cut or not? How would trade relationships around the world change as the US pulled back from its former world leadership role? Would the Brexit negotiations hang over the UK economy like Damocles’ sword for years to come? The financial path of Saudi Arabia, the largest oil producer in the Middle East, depended in no small way on how the initial public offering for Aramco goes in 2018, which in turn depended on the price of oil. How would Saudi oil production strategy change before and after the pending IPO? The Federal Reserve embarked on incremental plans to shrink its balance sheet with the European Central Bank followed with adjustments to its asset buying programs. How will asset classes that positively benefited from QE respond to the unwinding? Diplomatic tensions with potential military implications abounded.

Essentially, 2016 and 2017 highlighted that the world faces serious economic and political challenges with the likelihood of binary outcomes. That is, not only is the environment experiencing rising uncertainty, the probability distributions of potential market outcomes are decidedly not normal, often highly skewed, and sometimes even bi-modal, which means that generating returns has gotten markedly more difficult for investors.

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