The remaining quarters of 2014 remain full of potential for investment returns, but require a strategic awareness. The volatility created by the mini-emerging market crisis and the intense geopolitical tensions in Crimea are reminders of the unknown nature of risks that can affect markets, even when the pure economic fundamentals are improving.
The beginning of the year was full of promise with clear consensus on broad asset classes. But the consensus has been seriously challenged since then. The challenges have included the January effect on equities, the positive US-dollar view and the negative outlook for bonds. The market is, indeed, very versatile this year; and an investor should ask the consequential question of whether to base their investing on beta strategies or to take a more nuanced approach, using granular stock selection within sectors, bond segments or alternatives.
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Volatility spikes are compatible with a maturing bull market
Volatility has receded from its pre-crisis averages, but is punctuated by minor spikes that coincide with market corrections following periods of price appreciation. Periods of lower volatility may be associated with a building consensus regarding the positive direction of the market. Conversely, volatility spikes play the role of deconstructing the consensus. This is healthy. It avoids prolonged bull periods that can turn into dangerous speculative phases. We expect this behaviour to continue. Investors can take advantage of it by selecting active managers or buying protection when volatility is low to offset the impact of possible corrections. After all, this may be the volatility transcription of the notion of climbing the wall of worry and be a type of self regulation to tame speculative spirits.
Generating alpha with a broad selection of active strategies
But these sequences of bullish phases and spikes of volatility are, in fact, challenging asset managers to enter into levels of detail they may not like. Salvation can likely be had by developing multiple sources to generate alpha. There is solace in observing the divergence among and within sectors in terms of valuation (for example, materials versus consumer discretionary); the different drivers running the show in base metals versus energy commodities; peripheral European bonds versus Bunds; the gap among emerging markets between industrial and commodity-dependant countries. All this variety creates opportunities for security selection. Applying active strategies or selecting hedge-fund managers that are alert to this environment in the event-driven and long/short equity space can take advantage of these opportunities.
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By GlobalData2014 is a year when the stars are aligning. There is increasing confidence regarding the path of the global recovery with expected growth of 3.7%. This is a necessary condition, but unfortunately not sufficient. New challenges lie ahead. Companies need to surprise on the upside when delivering their quarterly earnings, and bond markets have to come to terms with the reality that the agenda for higher interest rates in the US is more relevant than the old tapering debate. There are also the geopolitics of a cold peace (if not a cold war) developing around Ukraine. All this argues for striking a balance between beta strategies that can add market risk in times of short-term weakness versus precision and variety in security selection.
