Investors have become “too complacent” in the calm before a potential storm for stock markets, according to Deutsche Bank’s Maximilian Uleer. Uleer, head of European equity and cross-asset strategy at the multinational German lender, said the historically low levels of volatility was a key concern since it signaled rising complacency within the market. Stock market volatility is usually indicated through the VIX index and is often considered a barometer of fear and uncertainty in the market. It’s currently at its lowest since the first quarter of 2020. “I’m surprised how calm the market is,” Uleer told CNBC’s “Squawk Box Europe” Wednesday. “I think we are exactly at that point where the market is getting too complacent.” @VX.1 mountain 2020-01-01 This tranquility, Uleer suggests, could be misleading and cause investors to overlook brewing risks such as the slowdown in the manufacturing and services sectors in China and Europe. Late last month, a purchasing managers’ index survey showed that China’s factory activity in June contracted for a third month . In Europe, activity in the dominant services sector fell last month and pushed the composite index down to 49.9. If the PMI drops below 50, this usually signals a contraction in activity, which Uleer views as a negative sign for markets. In addition, terminal rates (where central banks will finish hiking) are higher now than a month ago, and rate cuts, previously expected in the third quarter, are now predicted for later this year or the beginning of next. The Deutsche Bank strategist said this indicates that the market is pricing in a relatively tighter monetary policy in the near future, which can be a headwind for stock markets. Uleer expects the pan-European Stoxx Europe 600 index to rise by 4.6% to 480 points from current levels by the end of this year. The low upside potential reflects Deutsche Bank’s view that “average expected earnings to come down by 5% in 2023 and to rise by 5% in 2024,” the strategist said in a note to clients this month. Downside protection for investors Uleer also highlighted a number of opportunities for investors to lock in their gains for this year. “All the data you look at, they’re worse now. But the beauty is, this low volatility actually offers you the chance to buy put options quite cheaply,” Uleer said, expecting market turbulence in the near future. Put options are derivates that gain in value when the underlying asset declines. As an example, downside protection for a portfolio worth 10,000 euros can be bought for a premium of 275 euros, or 2.75% of the total assets, according to data from Refinitiv for a Stoxx Europe 600 put option expiring on Dec. 15 with a strike price of 455 euros. In the illustrated example above, the portfolio would suffer a maximum loss of 3.41% even if the stock market declined further, not accounting for trading costs, by mid-December. In a volatile market, however, the premium paid for downside protection is often significantly higher than current levels. .STOXX 1Y mountain Government bonds Aside from options, Uleer also pointed to another defensive strategy — increasing the weight of government bonds in one’s portfolio. “We now finally have a very strong negative correlation of government bonds with equities. The correlation is now -0.6, which we haven’t seen since 2008,” Uleer said, implying that government bond prices are likely to rise by 60 cents for every dollar worth of decline in stocks. In addition, since inflation is also likely to “come down a lot,” Uleer said, the attractiveness of government bonds will also rise as they will offer a real positive yield. Potential upside Despite the near-term risks, the market strategist pointed to the travel and leisure sector for upside potential. “Airlines last year were telling us: ‘We have to increase ticket prices because fuel costs are up’. Well, this year, fuel costs are down 50%, but ticket prices are up 20%,” Uleer said. “We think that sector is going to make more than double the earnings they did last year. So even though they’re up 25% year to date, we still think there is an upside.”
This story originally appeared on CNBC
