Reacting to volatility
GAM’s investment experts react to market moves this week that have marked a return of volatility after an unusual period of calm.
Larry Hatheway, group head of investment solutions and chief economist
The most outstanding feature of the adverse market movements has been the discrepancy between shifts in equity prices and those of other assets. Long equity and short equity implied volatility were among the most crowded trades, meaning that risk management manoeuvres in response to the initial market action accelerated the sell-off. Nevertheless, while technical factors may have contributed to the extent of the adjustment, the source of it appears to have been driven by fundamentals as market participants come to terms with the beginning of the exit from the so-called “new normal”. With the prospect of rising inflation both crimping corporate profits and making forthcoming monetary policy less predictable, we believe that expectations for equity returns need to be revised lower while implied volatility will rise from previously depressed levels.
Ali Miremadi, investment director for global equities
We have long anticipated a pick-up in inflationary pressures and have consequently positioned the global equities portfolios to benefit from a higher interest rate environment. Rising interest rates are likely to cap equity valuations but strong companies will benefit from growing earnings in an improving global economy. Therefore, over the medium-to-long term, such shares can rise in line with earnings, providing a positive following wind for returns. We expect value strategies to perform relatively strongly and dispersion to increase. This will be a tide which will not raise all boats equally. It is therefore imperative to focus on corporate fundamentals and stock picking. In the short term, there may well be further technical shocks as a highly-leveraged community of traders adjust to a less correlated environment. However, in the long term, the stock market will, as ever, reflect the earnings power of the underlying companies. We therefore plan to continue focussing on the fundamentals in an improving economic environment.
Niall Gallagher, investment director for European equities
We do not think the recent market sell off is based on any reflection of the state of economic growth or company fundamentals in Europe. Instead it may reflect a market reaction from very low levels of volatility to more normal levels of volatility and consequent short term repositioning by some market players. The fundamentals for European equities are very good with strong economic growth, good earnings growth by corporates and no more than average valuations (ie neither cheap nor expensive).
Paul McNamara, investment director for emerging markets fixed income
We see no particular reason for panic as economic data remains strong in the US and Europe, and the outlook for global growth is robust. This should continue to support local currency emerging market debt, building on the strong performance over the last two years. Emerging market currencies are fairly valued, and EM trade balances are solid. Therefore, we are in a fundamentally different situation to all preceding EM currency selloffs of the last 20 years. We are watching the US dollar, which could rally if the Federal Reserve is forced to change its stance from the current proactive, preventive tightening to a more aggressive policy as a result of a clear pick-up in US inflation. However, based on the most recent data, this is not our expectation at the moment.
Tim Haywood, investment director for absolute return fixed income strategies
Policy rates are moving up across North America and the UK. After years of interest cuts, most central banks have reached a nadir. In the case of Europe and Japan, any change in policy could be very slow to arrive. That will disappoint some short sellers. But removing the most aggressive of emergency measures, to return short-term rates to zero or positive territory, would not be contractionary as much as eliminating distortions. 2018 could see particular weakness in five-year bond prices in these countries. More widely, bond markets are losing the tailwind of declining policy rates that they have enjoyed, in one country then another, for nearly 30 years.
Anthony Smouha and Gregoire Mivelaz, co-fund managers of credit strategies (Atlanticomnium SA)
While we have seen some huge swings in equity prices, the important aspect for our strategy in times of uncertainty is the strength of the credit quality of the companies in our portfolio. Recent earnings announcements have been in line with our expectations and confirmed the positive view of the companies whose securities we hold. Our approach is geared towards providing relative insensitivity to rising interest rates, but we are monitoring prices carefully and could seek to take advantage of excessive price moves by adding to some of our favourite positions (which we already have done to a small extent, locking in to attractive yields). Our utmost consideration is to ensure the strength of our credits and to remind ourselves that, even if prices move up or down on a mark-to-market basis, the coupon income which drives our portfolio returns is accruing daily at attractive levels, the credit quality remains strong and the pull-to-par should reassert once volatility subsides.
GAM Systematic Alternative Risk Premia team
Markets started to get jittery by the end of January and February saw selling escalate throughout the first three days of trading as US investors played catch up with inflation and a possibly faster path towards rate increases. While this is generally still seen as a healthy correction, the S&P 500 erased year-to-date gains as of the close of 5 February. At the same time, the VIX spiked to its highest levels since 2015 (38.8 intraday on Monday and further volatility after the close), US treasury yields reached around 2.85% before they started to be bid as safe heavens assets, while the US dollar somewhat reversed its downtrend, gaining 1% against its developed peers throughout 2 and 5 February. While the two day correction spread to global assets, initially leaving no place to hide, investor consensus remains on the positive side, as this is seen as a healthy retracement given future expectations on macroeconomic variable developments. Fingers are pointing to ETF selling and broad investor de-risking as weighing on the magnitude of the price moves witnessed. January saw the highest volume of inflows into ETFs and this momentum has somewhat turned in those flows in the past few days.
While Friday’s equity-led sell off was broad in that it touched all asset classes, Monday’s was closer to a risk asset sell-off move, with safe haven assets gaining. As a consequence there was no real “place to hide” as bond yields initially increased, equities tumbled and sold off aggressively, and other markets followed. In all, the market moves at the beginning of February have proved challenging, principally on the back of the breadth of the sell-off which included reversals in very many markets. We are closely following and tracking the situation as the market gyrates. The small portfolio losses produced in alternative risk premia during this period are not at all out of expectations and stress tests and appear in line with the wider peer universe of funds seeking active diversification for clients over the cycle.