2013 proved to be a revealing lesson in risk and reward, where high rates of return were not always necessarily accompanied by proportionately high levels of risk, and negative or low returns were not necessarily volatile.
The risk-return chart of 21 securities (15 equity indices, 2 bond indices and 4 commodities) shows the percentage price change over the 12-month period ending on January 3rd (proxy for 2013 performance) on the x-axis, and the 90-day volatility, ending on the same day on the y-axis. Here are the findings:
Equities vs volatility vs currency return
The Nikkei-225 is up by a remarkable 53% and 20% volatility over the last 90 days. But with the yen losing about 25% against most major currencies over the last 12 months, investors without a currency hedge would have seen those returns diluted significantly. NASDAQ is the most attractive equity index in terms of performance relative to volatility, with a 33% price change and 12% volatility.
Germany’s DAX-30 has offered the best combination of price performance, volatility and currency returns over the last 12 months, considering the euro’s appreciation against all major currencies.
China’s Shanghai Composite and Hong Kong’s Hang Seng indices also fared on the negative return axis but showed relatively lower volatility than the 2 precious metals. This is highlighted by the fact that recoveries in the Asian indices were tepid in comparison to the more aggressive, yet short-lived gains in metals. The false rallies in gold and silver seen in May and August were classic signs of summer bottoms, albeit limited.
Bond yields: high volatility, surging returns
Yields on UK and US 10-year rose more than 40% over the last 12 months following all taper hints and warnings from the Fed, escalating last summer. Despite the Fed’s wrong-footing of the markets in September and the delinking of interest rates from asset purchases, bond yields have had the highest gains as well as the highest volatility. The swings in yields were significant; -19% in Q1, +60% in Q2, -15% after the September “no taper” decision, followed by a 21% rally from November.
Commodities: High volatility, low return
Out of the 21 securities, silver, measured in USD, shows the worst performance return and highest volatility, while gold follows behind in risk and return with a 24% decline and 20% volatility. US Crude WTI and natural gas 2 of the 4 commodities to have avoided declines in 2013 (the others were cotton and palladium) but natgas fared as among the most volatile of all 21 securities –behind bonds.
As the Fed plans to temper yields’ gains near the 3.20%-3.30% level, the clash between dovish and hawkish Fed speakers at the newly-led central bank will bear its share of volatility in fixed income markets. Commodities will not escape volatility either. The Fed will strengthen its dual mandate policy by likely cementing its price stability objective into an inflation target, which will trigger a bifurcation in inflation expectations and commodity price performance.