Mid-Year 2022 Review: Nine Sources of Increased Risk

While there is always uncertainty in the outlook for the economy and financial markets, a confluence of events has increased that to high levels. The VIX, a measure of volatility, has ranged between the mid-20s to the mid-30s throughout May and June. A range of 13-19 is average, while levels above 20 are both high and predictive of high volatility over the next month. Investors, and thus markets, dislike uncertainty. As a result, volatility has been negatively correlated with equity returns – when the risks of negative outcomes increase, investors demand larger risk premiums, driving P/E ratios down.

Unfortunately, not even good forecasters can predict what is going to happen in the markets. The best one can do is make sure their plans anticipate the regular appearance of negative shocks and that they address the risks of most concern, reducing them to an acceptable level. One can also learn from lessons history has provided.

One of those lessons is that while events can be shocking, investors around the world quickly adjust their expectations as new information arrives. Geopolitical events are widely followed by investors quickly incorporating new information into prices. Thus, unless they can forecast more accurately than the collective wisdom of the market – and there is no evidence of the ability of investors to do it well – it is already too late to act on new information. The result is that trying to time one’s allocation to risk assets has been proven to be a loser’s game.