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Economic Policy Uncertainty and Global Equities

It seems over the past few years the only certainty has been rising uncertainty, and the folk at Economic Policy Uncertainty have a set of indexes which map this trend out well. Their indicators use algorithms to generate readings based on the flow of news. As the charts below show, there are some important trends in these indicators, and a couple of key linkages with global equities and global stock market volatility.

The key highlights on global economic policy uncertainty are:

-The trend of the past decade has been for rising economic policy uncertainty.

-The peaks and troughs of policy uncertainty tend to line up with the swings and cycles in global equities, for a few good reasons.

-The spike in volatility is consistent with the rise in the economic policy uncertainty index, and the global equity market correction - and is a possible contrarian signal.

1. Global Economic Policy Uncertainty Trend: The first stop is to remark on the overall trend in global economic policy uncertainty, which has been on an almost consistent upward path. Aside from the broad trend there are clear spikes and troughs in the indicator, and visually this tends to map to the swings and cycles in global equities. Like clockwork, the indicator has made a particular surge in the October readings, which lines up with the heightened market volatility we've encountered. This makes sense both from the point of view that greater policy uncertainty is bad for markets, and bad market conditions also feed-back to foster policy uncertainty.

Global economic policy uncertainty vs global equities graph

2. Economic Policy Uncertainty - EM vs DM: Looking at the split across EM (Emerging Markets) and DM (Developed Markets), the trend is basically the same for both cohorts, the distinction however is that policy uncertainty right now is particularly elevated for EM economies. Again, tying this back to markets, it's EM equities that have really been under pressure this year, and this could be yet another contrarian sign that EM equities are set for a period of better performance.

chart of economic policy uncertainty - EM vs DM

3. Economic Policy Uncertainty vs Implied Volatility: Finally, tying it directly into the volatility picture, there has, up until the last few years, been a fairly close link between economic policy uncertainty and equity market implied volatility. There's a few possible ways to think about this chart: a. this is just an example of central banks at work (suppressing volatility with QE); b. investors have become immune or numb to the new-normal high levels of policy uncertainty; or c. implied volatility is "too low" or mis-priced vs the fundamentals. It could well be a combination of these, but it certainly lines up with our thesis that volatility has undergone a cycle low, and will rise from here as central banks move from suppressors to sources of volatility.

global economic policy uncertainty vs implied volatility chart

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