Vantage Point: Volatility  

Equity investing at a time of higher volatility

  • To understand the different influences on the present high level of volatility
  • To discover what happens to market volatility in wartime
  • To understand the impact of higher commodity prices on market volatility levels

For corporates revenue growth has been rewarded over the past decade, but we now expect to see valuation and margin resilience become much more important drivers of returns. 

Greater geopolitical complexity requires them to shore up their supply chains in this new world; for some that will mean margin compression, while others benefit from the resulting capital expenditure. Commodity prices are likely to remain highly volatile and elevated as supplies remain restricted or customers become more discerning around their sources, which will put upward pressure on some company's costs. 

Equally, the demand curve is shifting aggressively for some commodities as the green agenda intersects with the desire to escape reliance on Russian energy provision – electrification requires copper, lithium, steel, and a variety of other metals at scale. 

The emphasis on sustainability in capital allocation has been a building force for several years. The environmental drive towards net zero is powerful but the war in Ukraine necessitates supply shifts from Russia, which may require short-term decisions to increase production in other regions to ensure energy security as well as fulfil the social and governance obligations of stakeholder capitalism.

The longer-term trend towards net zero will hold firm and indeed will remain a key driver in Europe’s fiscal policy initiative. That has acquired more urgency as the block recognises the security vulnerabilities that reliance on Russian gas has created. The energy complex is likely to be an area of huge change over the following years.

Likewise, attitudes to security in the military sense have undergone a profound change since the shock of the Russian invasion. One of the most profound manifestations of the impact of the war has been the shift in consensus within Germany towards defence spending. What had been regarded as anathema on an ethical basis is now a matter of preservation of liberal values.  

If one believes volatility will be higher, a legitimate strategy is to take positions in volatility instruments available in different parts of the market, but those options are not open to all investors or managers. A broader approach is to follow the textbook method of dealing with volatility via diversification and extension of investment time horizon to avoid being whipsawed by violent market moves.

Over the past decade diversification would largely have hurt a portfolio, buying US technology or a growth index and sitting on the beach would have been great investment advice. Now diversification is likely to be more important. We think being more selective within geographies, sectors, currencies, and stocks will add greater value in the coming years.