Volatility makes an unwanted return
After an extended and almost unprecedented period of relative calm, which boosted the US stockmarket, we have seen some volatility return.
Concerns over global growth have re-emerged, the European debt crisis is again gaining headlines as the merits of austerity are being questioned and US economic data has been less impressive.
One potential benefit of this rise in consternation has been the long-awaited correction in stocks that many had been calling for.
In fact, we have been comforted on a contrarian basis by surveys that suggest a heightened level of bearishness among investors.
The American Association of Individual Investors’ (AAII) bull ratio recently moved decidedly below the 50 per cent mark for the first time in 2012. The percentage of respondents saying they are bearish has moved from just under 28 per cent to nearly 42 per cent between April 4 and April 11. Furthermore, the percentage of bulls dropped to 28 per cent from more than 38 per cent over the same time period. This change in sentiment was needed for the market to re-establish a sustainable upward trend.
The recent mild increase in volatility again reminds us that it is important for investors to maintain a long-term focus and a diversified portfolio. It is vital that they review the holdings in their portfolios on a regular basis, while also looking at how correlations among asset classes change over time.
A well diversified portfolio in one year may not be nearly so two years later. Even if the positions are roughly the same – the interaction between asset classes changes over time.
On portfolio construction, the drumbeat of bearish bond commentary has grown in the past month as yields remain near record lows.
While we again remind investors that investing in bonds for speculative or capital appreciation purposes has become more risky, it is also true that for diversification, income, and capital preservation purposes, bonds will
still have a valuable place in many portfolios. Again, balance is the key.
Meanwhile, investors’ attention has again focused on the macro rather than the micro in the past couple of weeks – the height of the reporting season for earnings in the first quarter.
The reporting period has been much better than expected, although admittedly from a lower bar. In total, 83 per cent of companies have beaten expectations so far – an all-time record high.
But market reactions to good reports have been more muted relative to the punishments doled out to those that disappointed.
It appears Chinese developments, concerns over European growth and debt and some softening in US economic data has led to increased volatility.
In the US, the economic expansion continues, but we may be in for yet another soft spot.
This isn’t surprising given the likely pulling forward of some economic activity that was influenced by the unusually warm weather during the winter months. We believe this is a relatively modest and temporary phenomenon and that activity will again pick up in the coming months.