Financial Mail - Investors Monthly
Offshore or onshore: looking for fuel for the tank
Expected market volatility makes predictions difficult
It’s been a bumpy start to 2015. Volatility is on the increase, and with good reason. Those investors who took a break over the festive season arrived back at their desks to one of the most event-driven Januaries in recent times. This has set the scene for what looks like an unpredictable year for markets.
While oil continued its slide to take its losses since mid-2014 to 60%, the Swiss authorities surprised the market by allowing the Swiss franc to float freely against the euro. This caused the Swiss stock market to decline by almost 10% in a single day, and the franc’s 10% appreciation caught currency traders off guard. Then there was the European Central Bank’s long-awaited decision to start buying sovereign debt. The move was not completely unexpected, but it added to a host of factors that are fuelling the uncertainty.
According to S&P Dow Jones indices, the volatility of the benchmark S&P 500 index in the US was nearly 10% higher than its 50-year average. However, it’s the intraday fluctuation that has been more dramatic, with the S&P swinging more than 1% in trading for 16 consecutive days in January. The VIX, the Chicago Board of Options Exchange Volatility Index, which measures expectations for swings in the S&P 500, averaged about 19 through the violent moves in January, 34% higher than last year’s mean of 14.
“We try not to forecast what markets will do as it’s almost impossible,” says Glenn Silverman, chief investment officer at Investment Solutions, SA’s largest multimanager. “One of our predictions, though, is that the capital markets are going to be increasingly unpredictable. Volatility is likely to increase further, which is typically of concern to markets.”
It has always been hard to predict where markets will go, but Silverman says it’s now almost impossible.
“Take the case of the US 10-year bond in 2014. Every global market commentator or forecaster, bar one, said those yields would go higher,” he says. “But they didn’t — they fell, and sharply too, providing a very strong and unexpected return.”
Oil’s dramatic slump and the Swiss authorities’ unexpected move may have added to the mix, but it is central bank policy that has been the primary driver of markets for a number of years.
“Whether rightly or wrongly, this has been the theme since the end of the global financial crisis,” says Silverman.
“As long as the market believes that central bankers will react to poor economic data and conditions, it ignores that bad data. It has arguably led to bubbles and a move away from true fundamentals.”
This has created a more difficult environment for active money managers to operate in, as markets now react more to the announcement of new stimulus or the withdrawal of old stimulus than to (worsening) economic fundamentals or even valuations.
“Clients are asking why they should invest with active managers,” Silverman says. “I’ve commented that it’s getting very hot in the asset-management ‘kitchen’. The policy measures are distorting what many managers would consider to be the true fundamentals, resulting in performance numbers that are far from stellar.”
He says the market was already second-guessing — or had
It is central bank policy that has been the primary driver of markets for a number of years
In a low-yield world, however, Brooke still sees the best returns coming from equities, particularly the high dividend payers
been informed about — European Central Bank president Mario Draghi’s announcement of further stimulus measures in January (the European equivalent of quantitative easing). So after Draghi announced sovereign debt purchases, the subsequent market reaction was rather muted.
“The efficacy of these policies — their ability to move markets — seems to be diminishing,” Silverman says. “The authorities won’t be happy with that, nor will many market participants, but it may actually be healthier in the long term.”
Apart from central bank stimulus, the most significant development of the past year has been the dramatic fall in the oil price. Not a single market commentator or forecaster predicted a sub-$50/barrel oil price.
“Some may have predicted it would fall, but nothing close to this magnitude,” Silverman says. “It’s a huge move and there are many competing views as to why it happened. Either way, the full consequences of the fall are likely to be significant, and are still to be felt.”
Almost as fascinating as the fall itself has been the market’s response.
While cheap fuel may boost consumer spending, which is good for stock markets, an estimated one-third of all capital
expenditure on the S&P 500 is driven by oil and oil-related sectors, so in that way it is bad for earnings and markets. What is good for “Main Street” may now be bad for “Wall Street”, and that is not necessarily a bad thing, says Silverman.
“The economies of oil-producing countries like Venezuela, Nigeria and Russia and a large part of the Middle East are going to struggle and you can already see the market reaction,” he says. “As an example, the Russian currency and equity markets have been slammed. The Nigerian currency, too, has taken a beating and even non-oil companies associated with the country, such as MTN, have been negatively impacted.”
Peter Brooke, who heads Old Mutual Investment Group’s MacroSolutions boutique, believes the sharp drop in the oil price has reduced risk in the market by improving growth prospects in the eurozone and possibly averting a breakup.
“At the same time, lower inflation ensures ample liquidity in Europe and Japan and reduces the risk of climbing US interest rates,” Brooke says. “Better growth and easy liquidity provide a much-needed fillip to global equities.”
Brooke is concerned, though, about the threat to profit growth for JSE-listed companies coming from lower economic growth and falling commodity prices.
“The result is that we expect a reduced real return of 5% from this asset class, which is way off the long-term (since 1925) real return of 8,1%,” he says.
In a low-yield world, however, Brooke still sees the best returns coming from equities, particularly the high dividend payers.
“As a result, we are overweight financials in SA and overweight global equity,” he says. “SA bonds are benefiting from the surprise potential improvement of SA’s economy and currently have one of the highest yields in the world on both a real and a nominal basis. We are therefore overweight SA bonds, especially long-dated bonds.”
To handle the heightened volatility, Silverman suggests
using a multi-asset class manager rather than a single-class manager such as equity-only.
“Let these expert managers deal with the volatility; they can do so a lot better than the man on the street can,” he says. “The Investment Solutions Performer fund is such a multi-asset fund, and is our largest by some way. The fund has performed strongly and gives managers the discretion to move between asset classes, regions and currencies.
“Nothing says the managers can’t make mistakes — they do — but I rate their chances higher than those of the average or even expert investor.”
Some managers, especially the more value-oriented ones, follow a strategy of looking for the unloved sectors or stocks, rather than sticking with the winners and following the momentum. There are many opportunities at present to the contrarian investor because many areas have been hit hard. These include oil stocks, commodity or resource shares and emerging market stocks, says Silverman.
“Emerging markets have done very badly of late, including major countries like Brazil and Russia — in terms of both their currencies and their stock markets,” he says. “It takes huge guts and patience to be a deep-value, contrarian investor. Few have the ‘balls’ to stick with the perceived losers.”
However, SA would typically not be one of the favoured markets as it has performed strongly and is perceived to be expensive. There is also a growing list of macro concerns, especially government policy and energy shortages. The lower oil price is a big positive, though.
“One simply cannot predict or call every turn in the market,” Silverman says. “One needs expert managers focused on these aspects, and with the resources and skills to do it.
“Diversification is critically important too. As an example, many ignore the South African property sector, yet it has outperformed the South African equity market over many years.
“And then downside protection requires additional expertise too, for example, the use of derivatives.”