Volatility Is at ‘Normal’ Levels, Says CalSTRS

The $186 billion public pension’s risk team has analyzed recent market turbulence and some seldom-discussed tail risks.

Stock market volatility has not hit “outlier” levels despite heavy losses in the first few weeks of 2016, according to the California State Teachers’ Retirement System (CalSTRS).

“Since a burst of volatility surrounding the Chinese equity market, the past few months have seen very little turbulence,” the pension’s innovation and risk team argued in a board report CIO Chris Ailman presented last week. 

“Despite tragic events in different parts of the globe, market turbulence is largely in the ‘normal’ range.”The S&P 500 has fallen nearly 5% since the start of 2016, including a 2.4% drop on January 7, as turmoil in the Chinese equity market and declining macroeconomic data in Asia’s largest economy panicked investors.

In its analysis, CalSTRS said highly volatile days tend to happen in clusters. Since the last period of higher-than-average volatility in August 2015, there has been only one “outlier” day. “Several days in a row of outliers are a strong indicator that market turbulence could persist for many weeks or months,” the report said.

“During normal periods, we would expect to see about five or six such outliers in a 90-day period,” the report said. “Despite tragic events in different parts of the globe, coupled with news headlines and increased volatility across markets, market turbulence is largely in the ‘normal’ range.”

The innovation and risk team detailed two “special analysis” case studies looking into tail risks to the CalSTRS portfolio.

The first involved an investigation of the political outlook for a number of countries to identify those with heightened risk of disruption or violence.

The three key factors for identifying such countries were a “disproportionately young” population, a high reliance on agriculture exposing the country to climate change risk, and a weak political environment. It detailed the effects of a drought in Syria and the role in the ensuing violence in the country, as well as other “conflict research” material.

Chris Ailman, CalSTRSCIO Chris Ailman presents the report to the CalSTRS board. Source: CalSTRSCalSTRS’ report also included a map of the regions it identified as the most susceptible to violence.

“Not surprisingly, much of Africa and portions of the Middle East are at greater risk,” the report said. “Perhaps more surprising is India, which has relatively better governance than the rest, but a high reliance on agriculture and a young population.”

Finally, the risk team looked into links between terrorist attacks and economic recessions. An analysis of the economic aftermath of attacks in the US, UK, Spain, Norway, and Japan showed “a 3% to 5% chance that a terrorist attack will cause a recession.”

“In September 2001, the month of the largest attack in our sample, retail sales were down considerably,” the CalSTRS report stated. “However, sales rebounded strongly in October 2001, with no measurable effect within three months of the attack. The historical evidence suggests that the economy is robust to moderate to large attacks.”

Read Ailman’s latest investment report, which includes the risk team’s analysis.

Related: The Psychology of a Sell-Off & CalSTRS Restructures to Bring More Assets In-House