23 April 2018

Your Weekly Market Focus
 
Volatility Is Not All Bad…

Author: Vasu Menon, Senior Investment Strategist, Wealth Management Singapore, OCBC Bank, Member of OCBC Wealth Panel

The return of volatility was the big story of the last quarter.

Naturally, many investors have been unnerved by the increased volatility. However, just because stocks were down in the last quarter does not mean that market fundamentals have deteriorated. Volatility can work in investors’ favour, as long as they keep an eye on the longer term picture and leverage upon it as part of a disciplined investment plan, while staying diversified across various asset classes.

Late last year, we had mentioned that the investment environment will be challenging in 2018, as most asset classes are showing high valuations and various developed economies are following the U.S. towards monetary tightening.

No one could have anticipated the extent to which investments would be challenged. And this is just in the first quarter alone.

The CBOE Volatility Index or VIX Index best depicts the upheavals the stock market has experienced so far over the quarter.

The VIX Index, which measures expectations of near-term volatility via S&P 500 stock index option prices, is sometimes called the “fear gauge.”

Volatility-Is-Not-All-Ba-1-1The index practically exploded in early February 2018, which was the start of the market correction after an epic run that had seen the S&P 500 Index price trotting happily through much of 2017 without any major corrections; so when the correction finally did happen in 2018, it was sharper than normal.

The spike in the chart happened on 5 February 2018, when the Dow Jones Industrial Average was down more than 1,100 points, its largest one-day point decline on record. Intraday, the index suffered its first 10 per cent correction since January 2016. Meanwhile, the S&P 500 shed 309.59 points while the Nasdaq lost 273.42 points.

Markets have lost their charm?

Since then, we have had several episodes of volatility. The market’s brief moments of calm are often outdone by hairy moments threatening to wipe out gains for the year, be it fears of the Federal Reserve hiking interest rates faster than usual, growing trade protectionist tendencies or the recent air strikes against Syria.

Specific sectors too have had their nervous moments. Technology was hit by privacy-driven concerns and the sector’s substantial weight in the index helped drag down broad indices too.

Naturally, many investors have been unnerved by the increased volatility.

However, just because stocks were down in the quarter does not mean that market fundamentals have deteriorated. Sure there have been corrections, but it is important to note that global economic growth remains on pace.

In the U.S. for instance, job creation continues on pace with unemployment levels remaining low. Europe is starting to recover nicely from the economic and political issues of the past decade while China has succeeded in slowing the pace of credit expansion without having a noticeable effect on economic growth.

In the technology sector, where Facebook took a hit over the handling of user data, its share price closed at US$164 on 13 April 2018, and notched its biggest one-week percentage gain since March, when its share price had hit a low of US$152.

Instead of being wary, investors may want to use these periods of price swings to accumulate assets in the market. For example, investors may consider a regular investment plan to capitalize on attractive entry points should higher market volatility persist.

Another way investors may benefit from the periods of higher volatility would be through funds that generate income through the use of covered calls. The uptick in volatility generally provides a premium on the sale of these options, in turn helping the fund generate a better portfolio yield.

The annualized yield for the fund in March 2018 was 5.47 per cent per annum.

Focus on fundamentals, not noise

Amid the noise that dominates, it is easy to forget about the more mundane things that typically drive markets: fundamentals.

While global PMI’s seem to be softening, the overall trend is still quite healthy.

Volatility-Is-Not-All-Ba-2PMIs point to some loss of momentum

This is the case in the U.S., and the reason for us to expect the Federal Reserve to hike interest rates three more times this year.

The other fundamental factor driving equity markets is earnings. Recall that in Q4 2017, earnings were solid.  All signs indicate that Q1 2018 earnings reports will be driven mostly by positive factors, not negative ones.  The recent U.S. corporate tax cuts should also provide strong momentum for the year.

Make volatility your friend

In the current climate of tweet storms and trade bluster, a steady run of solid corporate earnings may be just what the market needs to bring some semblance of stability to markets. And a dose of reality after the unusual low volatility that was 2017 may be what investors need.

Ultimately, volatility can work in our favour, as long as investors keep an eye on the longer term picture and leverage upon it as part of a disciplined investment plan, while staying diversified across various asset classes.

 
OCBC MoneyMonday™