In equity markets, the descent can be more hazardous than the ascent

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained some poise over recent weeks, further market falls are possible against the volatile backdrop. Is it best to keep chasing momentum and growth or to hunker down and invest in companies with more defensive qualities?

In attempting to answer this question, it is informative to look at 40 years of data from the S&P 500 index of US equities and the asymmetry between the effect of falling markets and rising markets on investors’ overall returns. Put simply, it has been far better for investors to miss out on the 10 worst market days over the past four decades, than to have missed out on the 10 best days.

To draw on a mountaineering analogy, many more climbers die on the way down from the summit than on the way up. Much of this could be down to the fact that a climber will use up the majority of their resources on the way up, and will be more tired physically and mentally on the descent when many of their supplies have been exhausted.

Similarly, the asset inflation driven by loose central-bank monetary policy and the abundance of cheap debt has helped propel markets to historic highs, but as resources are increasingly withdrawn, there is far less left in the tank to sustain the markets’ upward trajectory.

To us, using the mountaineering analogy again, the message seems clear: it is more important to acclimatise, prepare properly and manage resources prudently to boost your chances of surviving the descent. In the case of equity markets, we think one way to achieve this could be to invest in companies with strong balance sheets and visible, recurring cash flows that can be captured in the form of dividend income, to help augment returns when markets are volatile or on their way down.

Nick Clay – portfolio manager, Newton Investment Management.

A correction at the end of January has ushered in a period of relatively heightened volatility through 2018, as markets have come to focus more on potential headwinds and attention has started to swing away from growth-orientated stocks, to ones with more defensive qualities, better able to operate through more challenging market-cycle conditions. In our view, while markets have regained … read more

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Dispelling the myth: Volatility can be positive for returns

In 2017, the global economy transitioned from a period of sluggish, US-dominated growth, to a more synchronised global recovery. With inflation still well behaved, corporate earnings grew strongly, buoying both equity and credit markets and suppressing volatility, which reached historically low levels.  So far, 2018 has proved more challenging for some investors. Volatility spiked in the first quarter, driven by the unwinding of US volatility products and then compounded by an increase in global trade tensions and profit taking in US technology stocks. Unanticipated volatility spikes generally hurt in the near term, but they can also offer opportunities. Although generally short lived, the fear of loss among investors drives risk appetite downwards, and derivatives markets become dominated by those looking to hedge against downside risk. As a result, risk premia in option pricing can become elevated and this can create greater opportunity for alternative, option-based strategies to deliver positive returns.

Steve Waddington – portfolio manager. Insight Investment, a BNY Mellon company

 

In 2017, the global economy transitioned from a period of sluggish, US-dominated growth, to a more synchronised global recovery. With inflation still well behaved, corporate earnings grew strongly, buoying both equity and credit markets and suppressing volatility, which reached historically low levels.  So far, 2018 has proved more challenging for some investors. Volatility spiked in the first quarter, driven by … read more

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Markets remain blinded by the light

Vix Index

While global headlines focus on continuing unrest in Iraq and worrying geopolitical developments in Syria and Ukraine, the mood among investors in global capital markets remains remarkably benign. Global market volatility remains unusually low by historic standards. In June, investors saw global stock markets reach record highs while the US Vix index – viewed by many as the key benchmark for expected US stock volatility – hit a new seven year low.

While these becalmed market conditions have offered welcome relief for some institutions – with government borrowing rates at or near historic lows – they are not good news for everybody. Low volatility can affect trading revenues, narrowing opportunities for investment banks to profit on trades. Nevertheless, the current environment appears to present a remarkably stable backdrop for wider economic recovery. A range of factors may influence volatility but in our view one central answer lies in the extraordinary financial policy stimulus adopted by various central banks – including the US Federal Reserve (Fed) – since the financial crisis. The unconventional monetary policies implemented in order to bring down interest rates faced by companies and households and spur growth have, in fact, boosted risk taking and total debt in the global economy.

Aron Pataki, Newton Real Return team

Source: Bloomberg

While global headlines focus on continuing unrest in Iraq and worrying geopolitical developments in Syria and Ukraine, the mood among investors in global capital markets remains remarkably benign.  Global market volatility remains unusually low by historic standards. In June, investors saw global stock markets reach record highs while the US Vix index – viewed by many as the key benchmark … read more

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QE – It’s a kind of magic

Markets are no longer following fundamentals

The post-crisis environment seems to be showing positive signs that QE has worked and we can look forward to strong, rising asset prices with minimal volatility. However, beneath the surface of this are the underlying problems existing that suggest investors should be expecting to see low returns and higher volatility for the foreseeable future. Primary indicators such as unemployment figures are generating ‘false’ signals, giving investors the wrong impression regarding the health of particular economies and consequently there is a misallocation of capital.

 

Nick Clay, Portfolio Manager, Newton.

The post-crisis environment seems to be showing positive signs that QE has worked and we can look forward to strong, rising asset prices with minimal volatility. However, beneath the surface of this are the underlying problems existing that suggest investors should be expecting to see low returns and higher volatility for the foreseeable future. Primary indicators such as unemployment figures … read more

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Low volatility breeds currency contempt

Volatility levels in major asset classes

Low volatility in the foreign exchange market has created a very challenging environment for anyone trying to generate returns. Consensus trades have been shaken out and many managers are now reluctant to take aggressive positions. We remain convinced that diverging central bank policy will eventually be reflected in exchange rates so maintain our short euro, long US dollar (USD) and short Japanese yen (JPY) positions. USDJPY has been highly correlated with US Treasury yields and the rally in bond prices is beginning to unwind with more positive data. The one area of FX where there is some momentum is emerging markets and we have been selectively buying high carry currencies such as the Brazilian real, but balancing it with short positions in other beta currencies such as the South African rand.

Paul Lambert, Head of Currency, Fixed Income, Insight

Low volatility in the foreign exchange market has created a very challenging environment for anyone trying to generate returns. Consensus trades have been shaken out and many managers are now reluctant to take aggressive positions. We remain convinced that diverging central bank policy will eventually be reflected in exchange rates so maintain our short euro, long US dollar (USD) and … read more

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