At the end of last week, global stock markets suddenly plummeted without an obvious catalyst and the sell-off continued into Monday. When we communicated with clients on Friday, our main message was reassurance – panic is not an investment strategy. The dangers of panicking were illustrated Monday morning as markets dropped sharply at the start of the trading day before recovering more than half of those initial losses by late morning, then falling again abruptly at the end of the day. This market violence is unnerving after such a long period of unusually tranquil markets and poses a real challenge for those wanting to maintain the discipline required to reach long-term objectives. At Monday’s weekly meeting, our Investment Strategy Team answered four questions which we believe should continue to reassure clients despite this jarring volatility:
1. Is this sudden tailspin the end of the long bull market in stocks that began in 2009, or is this just a long overdue correction?
While markets have been displaying worrying signs in recent months that a top may be forming, including narrowing market breadth, complacent sentiment and widening credit spreads, other classic signs that tend to foreshadow an extended bear market are not yet in place. Real interest rates are not yet rising and earnings expectations are not deteriorating at the rate they were earlier this year as the effects of the oil price crash on the energy sector have been digested. The yield curve is also not yet inverting, which is normally a reliable indicator of a recession and an inevitable end to the previous bull market. We are therefore reluctant to call this the top of the market rally that began in 2009.
2. What’s causing the sell-off and when is it likely to change?
Investors have been spooked by the sudden realization that an increase in short-term interest rates by the Fed may coincide with a further collapse in the Chinese economy, undermining the outlook for global economic growth. This has placed particular pressure on emerging market stocks and bonds, commodities and the oil price. This brew has been fermenting for a while and we have long been absent direct exposure to these stressed areas, eliminating a dedicated exposure to emerging market bonds over a year ago and to emerging market stocks earlier this year. We have been reluctant to call a bottom in the oil price, where fundamentals remain concerning for other reasons as well.
The current spate of volatility is therefore likely to subside when markets welcome the reality that an imminent Fed rate hike is reassuring rather than a source of concern, because the US economy continues to grow slowly but sufficiently steadily to continue job creation. A policy intervention in emerging markets that addresses the continued pressure from a strong US dollar may also soothe jagged nerves.
It may well be that the market continues to correct in the short term before these two events become a reality. In times of volatility, it is important to have a cash policy to ensure that spending needs can be met.
3. When are we likely to take action?
Balentine’s Investment Strategy Team uses quantitative models to help cut through the noise and emotion during times of elevated market volatility. The team has honed this discipline for more than two decades, spanning multiple market cycles. While over the past several months, due to factors mentioned above, the relative value and sentiment components have moved away from stocks, they remain in “neutral” territory overall and have not yet signaled a move to lower risk decisively. This model led us to de-risk strategies at previous major market tops in 2000 and 2008, allowing our clients to avoid most of the severe drawdowns that markets experienced then. Given its time-tested approach, we have a good understanding of model strengths and weaknesses and will have conviction when it signals it is time to act.
4. Are there any opportunities to take advantage of today?
Opportunities are beginning to develop, not the least of which are in the areas that have been hardest hit and where we have been absent. The outbreak of volatility may also give us an opportunity to further develop our themes of allocations to select international areas within Market Risk. After all, as Mr. Buffett says, “be greedy when others are fearful; be fearful when others are greedy.”
These are the reasons not to panic. In times of volatility, there is great value in keeping an investment discipline. Our media is notorious for contributing to the noise and causing frenzies similar to what we saw over the weekend and today. Of course, we are vigilant that this negative sentiment could turn into a deeper and more extended correction, and we stand ready to lower our risk posture even further. But for now, we believe that our strategies already have adequate safeguards in place to protect against this volatility. Investors will be well placed to take heed of the advice offered by Jason Zweig in this weekend’s Wall Street Journal.
Despite scary headlines and volatile markets, we have a proven discipline that has stood the test of time and served our clients well over many market cycles. As Adrian Cronje reiterated to Fox5 Atlanta’s Deidra Dukes on Monday, “so much of success in investing is not reacting to the latest news. What it takes to be a successful investor is to really understand what your goals are, what your time horizon is and how you build a strategy to maximize the probability of reaching those goals.” Please let us know if you have any questions.