Off­shore or on­shore: look­ing for fuel for the tank

Ex­pected mar­ket volatil­ity makes pre­dic­tions dif­fi­cult

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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.”




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