Volatility Returns as Investors Focus on Fed and Global Central Banks
Investors are once again focused on global central banks and what they may (or may not) do in terms of monetary policy.
In the U.S., economic data points are being analyzed in the context of how the Federal Reserve Board might to react to them and if they are likely to prompt the Fed to raise short-term interest rates at its meeting this Wednesday. Investors who hope that the Fed will hold rates steady and keep borrowing costs low were generally encouraged by news of a decline in retail sales in August, and by comments from one Fed governor urging continued prudence with monetary policy. That said, there is uncertainty about the Fed’s next move, which appears to be contributing to increased volatility in global financial markets.
In the coming weeks, other central banks such as the Bank of Japan and the European Central Bank will present internal reviews of the effectiveness of their economic stimulus policies. Some investors believe these reviews will lead to a reduction in the central banks’ stimulus efforts, and that market volatility could rise if that occurs. Our belief is that a continuation of accommodative monetary policy is needed given continued weakness in many global economies.
Elsewhere, China announced better than expected economic data on several fronts, including industrial output, retail sales and aggregate financing.
Mergers and acquisition activity increased last week, as global corporations took advantage of industry consolidation opportunities. In the agricultural sector, Germany’s Bayer acquired Monsanto, while fertilizer companies Agrium and Potash combined in a merger of equals. In addition, major deals were announced in the technology sector, with HP agreeing to purchase Samsung’s printer business and Renesas buying chip-maker Intersil.
GAIN: Active Asset Allocation
Global stocks stabilized somewhat last week after declining the previous week. Going forward, market volatility may be modestly higher than it has been in recent months, as traders return from vacation and as key events such as the Fed’s policy meeting and the November election approach.
Although markets may be choppy, we remain bullish on equities—small-cap stocks and emerging markets shares, in particular. The financial and technology sectors are also attractive and we have taken direct positions in them.
In the fixed-income markets, we continue to emphasize corporate bonds due to their strong balance sheets and their attractive yields relative to sovereign government securities.
PROTECT: Risk Assist
In the wake of global equity losses of approximately 3%, volatility rose considerably. The CBOE volatility index (VIX), which measures expected future levels of volatility, quickly shot up from 12 to 18.
This might seem like an extreme spike in volatility given just a 3% move in stock prices. But it can be explained by speculative positioning (very long risk) combined with a large increase in VIX-focused exchange traded funds that experienced forced buying and selling due to market conditions. For example, one VIX-focused ETF on Tuesday traded 109 million shares—more than any single stock in the S&P 500 that day. This is the first time this has happened in the history of these ETFs.
SPEND: Real Spend
Trading volumes and volatility rose last week, with yield-sensitive areas of the market such as real estate and master limited partnerships (MLPs) experiencing losses due to concerns about the possibility of a Fed rate hike in the near future.
Real Spend’s holdings, aimed at generating above-average yields, are chosen in part on their potential for achieving below-average volatility as well. Thus, Real Spend tends to emphasize investments such as dividend-paying stocks and preferred stocks that historically have been less risky than real estate and MLPs. Real Spend’s yield-focused holdings offer a broader, more diversified approach, and therefore may maintain their values better when interest rate volatility rises.