12 June 2018
By John Husselbee, Co-Fund Manager HC Verbatim Portfolio Growth Funds
After a bull market stretching back as far as 2009, recent dips in equities have understandably made many investors wary of this coming to an end. And while several indices have already recovered losses, rising volatility has led to questions as to whether the falls earlier this year were merely a correction or the start of a potential bear market.
Stating our position at the outset, we are very much in the former camp but, before explaining why, it is worth reviewing how markets reached the current position.
Since the financial crisis of 2008, we have had an unprecedented period of loose monetary policy, with billions being poured into developed markets via quantitative easing. As markets have recovered and we have begun moving into a period of higher growth and higher inflation, this largesse from central banks has started to taper off.
In the meantime, particularly in the last couple of years, we have also seen significant political volatility, including Brexit, Donald Trump’s election in the US, the growing populist tide and other surprise election results around the world.
Our approach throughout this period has been to ignore the headlines and focus on fundamentals, but with so much noise this is easier said than done. While making political predictions has been a fool’s game over recent years, one thing we can say with certainty is that these events cause uncertainty in markets – and in such a febrile environment, something like a bad jobs number or threat of a trade war can be enough to drag markets down.
We saw – and wrote – several articles last year on volatility, with the so-called Fear index in the US (known as the Vix) sitting at all-time lows. The index was around the 10 mark for much of 2017 and, to put these figures in context, the average since the Vix launched in 1990 has been 19.5 and the high, in October 2008, was above 80.
More recently, the index has started to rise and investors are asking whether we are entering a period of higher volatility, particularly with dampening factors such as QE coming to an end. Commentators have been wondering whether low volatility signals a spike to come and perhaps a bear market along with it.
So with all this going on in the background, how are we thinking about the correction versus bear market question and what does volatility – whatever the level – mean for our portfolios?
As stated earlier, we believe market falls this year were a correction rather than anything more serious and we were actually relieved to see some of the excess come out of markets. Over the years, intermittent 5% to 10% corrections have traditionally been a function of healthy markets and we had been expecting such a drop for several months when it finally occurred in February.
At that point, we echoed our long-held view: it was long expected, was unlikely to mark the start of a bear market and presents opportunities for patient investors.
Bear market ‘signals’ are difficult to pin down but three major market bottoms in recent decades – 1987, 2000 and 2008 – have all seen concurrent recessions. While the last couple of months have thrown up signs the global economy is perhaps not as strong as we thought, there is little indication of recession ahead and therefore a full-blown bear market seems unlikely.
Our view remains that the three Cs – China, commodities and central banks - are key to short-term market sentiment, and nothing is ringing alarm bells about these for now. There is still plenty of political risk and we can never discount black swans but, while equities are expensive, they remain supported as dividend yields continue to outstrip those available on bonds.
One thing to monitor is whether recent pullbacks are enough to shock markets out of the low-volatility environment of recent years, and we would expect a higher Vix in the months and years to come. This should not automatically be seen as a negative, however, as greater volatility means more dispersion between stocks and markets and more opportunities for active managers to add value.
One example of such an opportunity is the current disparity between growth and value stocks, and we have looked to take advantage by boosting exposure to the latter this year.
In terms of our portfolios in a more volatile environment, the ultimate effect would be negligible as our approach has never been about chasing risk. We run target risk portfolios within predefined volatility parameters and, while our strategic and tactical asset allocation is influenced by underlying volatility, we are never likely to make large switches into or out of asset classes.
We have seen many market pullbacks before and the vital lesson has always been to maintain investment discipline. Our style is naturally defensive and a winning by not losing strategy is built to withstand the natural ebbs and flows of markets and to help our investors get rich slowly.
Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The portfolios' investments are subject to normal fluctuations and other risks inherent when investing in securities.
Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use.