Surviving the peaks and troughs of market volatility

With a recent return of volatility to markets, after a period of consistently rising markets in 2017, investors should avoid rash moves, hold their nerve and stick to proven processes and strategies, says Clay.

Speaking at the 2018 BNY Mellon Northern Investment Conference in Edinburgh, he drew analogies between investment and mountaineering and said investors should be prepared for unexpected market shifts.

“Probably one of the most important mountaineering analogies is that most people die coming down a mountain, not going up it, having expended too much energy and resource in the ascent.  

“Investing is exactly the same. If you put too much risk in your portfolio on the way up you will not survive as there are always likely to be market events that will surprise you on the way down.”

According to Clay the current investment market is riddled with human bias that can mislead unwary investors. This bias, he adds, often persuades investors to change their approach at just the point they need to hold with their existing long-term strategies.

“When investors come under pressure they need a process they can continue to stick to, particularly when the pressure is at its greatest, in order to survive a variety of outcomes. Yet everything that is happening today suggests some investors are throwing caution, discipline and process out of the window. They are trying to do clever things at a time when they should be focusing on their basic long-term processes and strategies.”

Against a backdrop of widespread market distortion prompted by quantitative easing, Clay remains wary of what he believes may ultimately prove short-term market fads. In particular, he points to recent inflows into highly leveraged exchange traded funds in the US, the apparently limitless rise of so-called FAANG technology stocks and a recent boom in European high yield debt as short-term trends generating sometimes unwarranted market distraction.

“All too often markets are driven by a fear of missing out. We are naturally hardwired as human beings not to want to miss out on the next big thing. The reality is that identifying the best investments in areas such as technology can be incredibly difficult.

“Experience tells us that the meteoric rise of some investments, such as the FAANG stocks and the persistently rising markets we saw throughout 2017 could not go on forever. While 2017 was a near perfect market, there were many underlying risks some investors ignored which are now causing renewed volatility.”

Clay argues long term investors can gain more from narrowing their exposure to the worst performing stocks than often vain attempts to buy into the best returning investments in rising markets.

“Consistent philosophy and process should improve your chance of getting investment right and the key is avoiding the worst periods in the market rather than focusing on the best.

“As in mountaineering, the range of things that can happen is extremely wide. Investment is not about taking on a tonne of risk to reach the summit. It is about being able to survive and avoid the descents in markets – whatever the prevailing conditions.”

Commenting on the market outlook, Clay remains concerned by the legacy impacts of now unwinding QE – and the sheer volume of debt built up in some sectors.

“Many companies have spent the time of QE and the abundance of cheap credit to lever themselves up to the hilt. We are back to record levels of corporate debt when the interest cover of that debt is at an all-time low. All this should tell us something, but many prefer to remain ignorant of these facts in the hope of making ever more money.

“Given we have full employment and the longest bull run in history in the US markets, we may have reached the end of the latest economic cycle. Either way, it is important investors design the processes and strategies they can stick to to help them survive a variety of outcomes and difficult environments.”

The value of investments can fall. Investors may not get back the amount invested.

For Professional Clients and, in Switzerland, for Qualified Investors only. This is a financial promotion and is not investment advice. Any views and opinions are those of the investment manager, unless otherwise noted. This is not investment research or a research recommendation for regulatory purposes. For further information visit the BNY Mellon Investment Management website. INV01428 Exp 31 Dec 2018.

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