Selloff “Rational Response” to Rising Rates
In this Bloomberg Surveillance interview, Dr. Ashwin Alankar, Head of Global Asset Allocation, discusses current market volatility and why he doesn’t see the recent selloff as indicative of a sustained pullback in equities.
Mark Barton: The stocks in the U.S. continuing their three-day sell-off amidst the declines. What assets or areas are performing well? Ash Alankar is the Head of Global Allocation at Janus Henderson and a contributor to Bloomberg profits as well. Ash, thanks for joining us today. We’re off the lows in the U.S., marginally off the lows in Europe. Is there further to come in this decline we’ve seen in the equity space or are we nearing the end of the five, six-day sell-off?
Ash Alankar: Mark, thanks for having me on. Well, the sell-off that we’ve seen last week was a natural, but more important, a rational response to an increase in real rates. Real rates tell you everything about how assets should be priced, how risk premium levels should be set, because real rates represent the cost of capital for companies. If real rates increase it makes it increasingly more difficult for companies to generate excess profit. So the key question here is what is the trajectory of real rates going forward, and more importantly, what is the speed of that trajectory? We pay a lot of special attention to how the derivatives markets, in particular, the option markets are pricing downside risk as well as upside risk for various asset classes. And currently, based on the level of risk implied options when it comes to the downside of equities, they’re still quite moderate. Surely, they increased over the last week, but they increased from very, very low levels to more normal levels, so this is all part of the normalization. So to answer your question, we don’t believe we’re anywhere near a point where you could see a sustained pullback in equities.
Barton: That’s a big call. So as many are saying, Ash, this is a healthy correction. Are you noticing it might turn into an unhealthy correction?
Alankar: Right now, no. Once again, real rates are going to be that variable, which will dictate how painful the correction is and real rates are governed and dictated by Central Bank activity. So if central banks begin to raise rates, drain liquidity very quickly, you can see a sharp increase in the real rate and that’s when the economy can become quite fragile and the vote is still out on whether the economy can handle higher real rates. Real rates still right now are quite low in the U.S. They’re sitting at about 70 basis points. In Europe, they’re sitting close to -100 basis points, which is why financial conditions, even though rates have backed up since the summer of 2016, remain very, very accommodative.
Barton: Ash, you’ve got some interesting calls. European equities, they are least attractive. You like the UK. There’s a bit of a contrarian in you. What’s going on?
Alankar: So this is all dictated, this is all indicated by how the option market is pricing upside and downside. Europe is likely going to be the next major region that moves from a regime of highly accommodative monetary policy to tighter monetary policy. And it’s not clear just yet whether the European economy can handle increased real rates and whether they can even handle positive real rates. The real rates in Europe have been negative for the past many, many, many years. So the vote is still out, which is why we’re a bit nervous with Europe right here. But the UK. is quite far from entering a tightening campaign, as is Japan.
Barton: Ash, we’ll leave it there. Thanks for joining us today. Ash Alankar there, Head of Global Allocation at Janus Henderson, and of course, Janus Henderson Bloomberg profits contributor.