Webconference replay: Keeping volatility in perspective - J.P. Morgan Asset Management

Webconference replay: Keeping volatility in perspective

Contributors Stephanie Flanders, Talib Sheikh

Wracked by worries over global growth and the timing of the first US rate hike, the markets are still recovering from last week’s heavy losses. But for multi-asset investors, recent market volatility doesn’t mean it’s time to run for the hills. Instead, it’s time to diversify more and expect less, say Chief Market Strategist for the UK and Europe Stephanie Flanders and Talib Sheikh, Portfolio Manager, Multi-Asset Solutions.

Key themes
  • The scale of last week’s spike in volatility took many by surprise. The VIX – otherwise known as the “Fear Index” – breached the 50 mark for the first time since 2009 and the S&P fell more than 11% from its peak over six consecutive days. Strikingly, the S&P 500’s fall against its 50-day moving average represented a move of five times standard deviation, which has only happened twice since 1900: on Black Monday in 1987 and when Germany invaded France in 1944.
  • We see some of this volatility as related to market liquidity issues and the fact that many traders are away from their desks in late August. But it is worth noting that emerging market indices have been under pressure for some time, with the MSCI Emerging Markets Index starting to move earlier – and more extensively – than other markets in reaction to the situation in China.
  • Having risen strongly over the course of this year, the Chinese stock market began to experience a very messy decline at the start of the summer. Most global investors were reasonably relaxed about this, having predicted a pullback in this over-exuberant market for some time. It was also widely anticipated that China would eventually need to adjust its currency. What spooked investors was not so much these developments themselves, but the muddled way that Chinese policymakers handled them.
  • A downward move in the Chinese renmimbi of around 3% is not the end of world, and still leaves the currency much stronger in real terms than a few years ago. But investors worried that this could be the start of a long series of moves, and that China’s policymakers could be losing control.
  • This concern about China came against a backdrop of weakening momentum in emerging markets generally, which are particularly hard hit by recent declines in commodity prices – another side of weakening demand in China. We have also seen a stagnation of global trade, which has been growing at a slower rate than global GDP for the first time in decades.
  • All of these factors put pressure on emerging economies. They also mean that global growth is likely to be slower than we were used to before the financial crisis. But most of the developed world is still seeing reasonably healthy growth – and there are none of the tell-tale signs of an impending recession in Europe or the US. Without that kind of shift in the business cycle, it is difficult to see why we should be heading for a true bear market in the near future.
Investor implications
  • Some will see the recent pullback in developed markets as a buying opportunity. If you were buying equities before this turbulence, you would have to say they are better value now than they were a few weeks ago. Valuations measured by forward price/earnings ratios in Europe, the US and UK are not cheap, but this volatility has seen them fall back to their long-term average.
  • What we can say with greater confidence is that this is not a good opportunity to sell. The market decline of roughly 11% – at the lowest point – that we saw in the recent turbulence is very much par for the course in equity markets: in fact, the median intra-year drawdown in the FTSE 100 for the past 29 years has been 11.3%.
  • We have seen unusually low levels of volatility recently, in part due to the distorting effect of central bank policies around the world. But this is the stage in the cycle when investors should be expecting volatility to rise and returns to be more constrained by economic fundamentals.
  • When valuations are very cheap, investors can make mistakes in terms of timing and the price that they pay. But after a five-year bull market, where bonds and equities were initially driven by reasonable valuations and accommodative central banks, but are now no longer as cheap as they were, it’s more critical than ever for investors to carefully pick their entry point and price.
  • We don’t view market volatility as an opportunity to sell, or to aggressively re-risk. When these big moves happen, the bottom is tested again to work out fair value on assets. Our medium-term view, however, is that there is no need to panic.
  • Volatile markets and mediocre growth look likely, but this does not signal that a bear market is imminent. Instead, investors should steel themselves for more constrained returns and greater volatility, by diversifying more and expecting less.
Listen to the replay here

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