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Volatility is back: what‘s next

Investment experts from private banks and fund houses discuss portfolio positioning

The S&P 500 index entered correction territory overnight after a dramatic sell-off on Monday, and investors are touting the return of volatility in equity markets as the Cboe Volatility Index sails past 30.

Analysts are blaming the S&P 500 index’s sell-off on technical factors after support levels were hit, inducing stop loss orders.

TS Lombard’s head of strategy, Andrea Cicione said hedge funds, which had the second highest exposure to equities since 2007, were probably forced to liquidate leveraged positions. Momentum-chasing algos probably did the rest.

In fact, the 115% jump in the Vix on Monday spelt doom for products profiting from lower volatility.

On Tuesday, Credit Suisse said that it will begin early redemption for a popular inverse exchange-traded note that was betting on low volatility, after it lost over 80%. Nomura, too, announced the closure of a similar product.

As investors prepare for the return to normal levels of volatility, here are some recommendations from investment gurus in private banks and fund houses.

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The S&P 500 index entered correction territory overnight after a dramatic sell-off on Monday, and investors are touting the return of volatility in equity markets as the Cboe Volatility Index sails past 30.

Analysts are blaming the S&P 500 index’s sell-off on technical factors after support levels were hit, inducing stop loss orders.

TS Lombard’s head of strategy, Andrea Cicione said hedge funds, which had the second highest exposure to equities since 2007, were probably forced to liquidate leveraged positions. Momentum-chasing algos probably did the rest.

In fact, the 115% jump in the Vix on Monday spelt doom for products profiting from lower volatility.

On Tuesday, Credit Suisse said that it will begin early redemption for a popular inverse exchange-traded note that was betting on low volatility, after it lost over 80%. Nomura, too, announced the closure of a similar product.

As investors prepare for the return to normal levels of volatility, here are some recommendations from investment gurus in private banks and fund houses.

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Eli Lee, head of investment strategy

Bank of Singapore

Given that volatility peaked on the close in US markets, it is possible that there will be more systematic de-risking to follow through in the few days ahead.

We advocate that investors stay invested and remain prepared for heightened market volatility going forward.

Our preferred equities strategy comprise a barbell approach between cyclical sectors (prefer financials and consumer discretionary) and defensive (prefer healthcare and telecom) sectors.

Regionally, we have an overweight rating on European equities, which are supported by solid EU growth and an overall rotation towards relative value. Rising bond yields will benefit the European banking sector which is a major component of European market.

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Bernd Hartmann, head group investment research

VP Bank

In line with our expectation that market volatility would increase, we have already focused on hedging strategies and put a focus on individual stocks that have strong fundamentals and attractive valuations.

Dynamic investors may opportunistically take advantage of the currently high volatility by selling put options or buying reverse convertible notes on specific underlying stocks.

For these products, we recommend paying attention to defensive conditions, which means that the exercise (strike) price should be set below the current price level.

If the market continues to decline during [the] product’s life period, the purchase of the underlying stock will occur at more favourable terms.

Conservative investors are waiting for the first market reaction and then deciding which medium to long-term investment opportunities are most appropriate for their respective portfolio.

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Christophe Donay, chief strategist, head of asset allocation and macroeconomic research

Pictet Wealth Management

Volatility and increasing dispersion of returns this year should benefit alternative strategies (including hedge funds and real estate assets).

In hedge funds, event-driven managers are optimistic about the opportunity set across sub-strategies, and especially within M&A and special situations.

Within real estate, there are lots of opportunities in retail and logistics (which serves e-commerce) – whether that involves reconfiguring warehouses to suit the needs of online retailers or adapting other bricks-and-mortar assets.

Offices, which are under pressure to adjust to new trends such as higher-density workspaces and open floorplans, are another area that property investors are interested in at present.

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Richard Titherington, chief investment officer, emerging markets Asia Pacific equities

J.P. Morgan Asset Management 

Broadly we can think of Asian equities as being bifurcated into two camps. Those that ran up strongly in January such as Chinese retailers and Chinese banks that have now sold-off quite strongly and areas that were already turning down and demonstrating negative earnings momentum, such as the Apple supply chain. In that sense, it certainly hasn’t been an indiscriminate sell-off.

Interestingly some of the markets that underperformed last year have held up quite well so far, like the ASEAN markets. Taiwan from its peak is currently down about 8%, the financials have done quite well but the tech companies have struggled.

In terms of how we’re positioned across emerging market equities portfolios, we’re seeking to keep portfolio beta around 1% to ensure that we’re not overexposed, rotating out of more expensive stocks and into less expensive ones. Although we are not making big changes, we are seeing interesting opportunities potentially emerging in Chinese financials and EM tech stocks.

Going forward, we see more opportunity in the companies with better earnings momentum, such as financials and exporters.

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Geoff Lewis, senior Asia strategist

Manulife Asset Management

Investors should not act as if the stock market correction in early February means that we are facing the end of the market cycle, as some in the financial media have been so quick to suggest.

It seems reasonable to argue, as some US equity strategists do, that in 2018 the real economy will be competing more strongly with financial markets for the available marginal quantum of liquidity. That could still mean mid to high single digit returns from the S&P500 in 2018, accompanied by a modest price-to-earnings ratio (PER) contraction if earnings grow by 11 to 12 per cent as consensus expects.

To argue that the US market is currently facing a deep and lasting correction in what looks likely to be one of the best years for the US economy and corporate earnings since the upturn began is both unjustified and too bearish. It has not happened before. Not until wage inflation exceeds 4.0% year-on-year can we expect to see any significant pressure on corporate profit margins.

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Paul McNamara, investment director for emerging markets fixed income

GAM

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.

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Craig Burelle, macro strategies research analyst

Loomis Sayles

The shape of the VIX curve suggests that current levels of heightened volatility may not persist for very long. The curve is currently inverted, meaning futures contracts that price near-term volatility are now higher than contracts that price forward volatility in the months of March, April, May and beyond. This signals that market volatility is likely to cool in the months ahead.

Outside of technicals, the fundamental backdrop for corporate earnings and the US economy have remained robust. Globally, solid real GDP growth in 2018 and faster corporate profit growth remain key pillars to the bull market.

The correction, while broadly isolated to equities, is certainly a bump in the road; however, long-term fundamentals have remained positive. As equities find a level from which to rally, we will be watching other asset classes for signs of stress that could potentially impede our favourable outlook.

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Paul McNamara
Paul McNamara
68/135 in Bonds - Emerging Markets Global Local Currency (Performance over 3 years) Average Total Return: 3.17%
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48/519 in Equity - Global Emerging Markets (Performance over 3 years) Average Total Return: 25.99%
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