Friday 7 August 2020

Nostalgic Research: Flight to Safety

The next installment in our Nostalgic Research series is Flight to Safety, published in 2013.

In periods of market stress, the financial press interprets extreme and inverse movements in the bond and equity markets often as ‘flights to safety’ or ‘flights to quality’. The use of this nomenclature was prevalent between August 2004 and June 2012, a period marred by the Great Financial Crisis (GFC). 2020 marks its resurgence.

This week, investors flocked to cash, gold and investment-grade bonds, as the United States awaited approval from Congress for further stimulus to cushion the impact of the financial crisis caused by the Covid-19 pandemic. According to Reuters, trepidation over the fate of the package saw $7.4 billion of equity fund outflows. Gold, which broke through $2,000 to reach record highs this week, attracted $2.7 billion. Meanwhile investment-grade bond funds pulled in $14.7 billion as investors followed central banks, whose asset purchases are running at $2 billion per hour.

Using data on bond and stock returns authors Lieven Baele, Geert Bekaert, Koen Inghelbrecht, and Min Wei, identified and characterized flight to safety (FTS) episodes for 23 countries:

On average, FTS days comprise less than 5% of the sample, and bond returns exceed equity returns by 2 to 3%. The majority of FTS events are country specific, not global. FTS episodes coincide with increases in the VIX, decreases in consumer sentiment indicators and appreciations of the Yen, Swiss franc, and US dollar. The financial, basic materials and industries under-perform in FTS episodes, but the telecom industry outperforms. Money market instruments, corporate bonds, and commodity prices (with the exception of metals, including gold) face abnormal negative returns in FTS periods. Both economic growth and inflation decline right after and up to a year following a FTS spell. […] FTS may be as much or more about flight to liquidity than about flights to quality.”

Interestingly, the US dollar has lost significant value recently, making the current FTS episode rather unique. It bears comparing the current market dynamics, to those post GFC when this research was published.

Members can access the research via the Inquire Europe archives: https://www.inquire-europe.org/research/finished-research-projects/