Credit: NY Times – By Paul Sullivan
The stock market has been shaken by turbulence in the last few weeks, something it hasn’t experienced in a few years.
The Standard & Poor’s 500-stock index plunged more than 10 percent from Jan. 26 to Feb. 8, a sell-off that pushed the market into a correction. The S.&P. has since rebounded, regaining much of those losses. That type of volatility is a normal occurrence, but theories abound to explain what caused it.
Adam I. Taback, deputy chief investment officer for Wells Fargo Private Bank, said the volatility was the result of the economic expansion’s being in the seventh or eighth inning of a baseball game.
“We may have extra innings in this cycle,” he said. “But people are more cognizant that the equity markets have more risk in them. They’re happy that their portfolios are diversified but worried where they are in the economic cycle.”
Some try to take a more historical view. Jack Ablin, founding partner and chief investment officer at Cresset Wealth Advisors, said volatility typically arose for three reasons: a technical correction where stocks pause but continue rising because company fundamentals are sound; a correction that reflects a change in the business cycle; or a systemic correction, like the 1929 stock market crash or 2008 financial crisis.
“The one we experienced last week was the mildest,” Mr. Ablin said. In other words, just a technical correction.
Others think it was a return to the normal function of a stock market: Some days, investors sell more stock than they buy.
“When the Dow drops 1,000 points, that’s more a testament to the growth of the Dow,” said Francis M. Kinniry, head of portfolio construction at Vanguard. “That’s still just a 4 percent move, because the Dow is at 25,000. Dropping 100 points on the S.&P. 500 doesn’t get people upset, but it’s the same thing.”
Who is correct won’t be known for months, or years, when market historians look back. That’s cold comfort for investors who are worried now. A report on Wednesday showed that inflation pressures appeared to be building, heightening the anxiety among investors.
Pick individual winners. With wild swings in the markets, active investment managers — those who buy and sell individual stocks instead of allocating money to an investment fund that tracks an index — say their skills are more in need now.
They argue that stocks are going to begin to show differences and that their skills at stock selection will keep investors’ portfolios from being dragged down with an entire index. In other words, in a market where everything isn’t going up, selecting the best individual companies makes more sense.
Francisco Bido, the head of quantitative research and a portfolio manager at Cognios Capital, said he had reduced the number of stocks he invested in after the recent volatility. The move came out of conviction, not fear, he said.
“A lot of those big passive vehicles out there buy so many stocks because they have a mandate to track an index,” he said. “I think it helps to be a bit more concentrated. It allows investors to find a different avenue.”
His strategy is also an argument to know what you own. That’s good advice in any market.
But an indexing behemoth like Vanguard says that is an overused argument. Nearly 90 percent of active managers have underperformed the indexes they track, Mr. Kinniry said.
“It’s not an active versus index story,” he said. “It’s high cost versus low cost. They underperform because they’re charging too much for the ‘alpha’ they generate,” he added, referring to the return in excess of the market return.
Mr. Kinniry is correct that fees eat into any return, regardless of how volatile the market is.
Consider bonds carefully. Years of low interest rates have had the same lulling effect on investors as the steadily climbing stock market. But bonds, which remained low for years, are now returning a higher yield, adding pressure to the shaky stock market.
But rising interest rates could eat away returns for individual investors. Driving this worry is a new chairman of the Federal Reserve, Jerome H. Powell, who took charge on Feb. 5, as the stock market dipped.
An alternative to bonds for affluent investors is private debt, which provides loans to small and medium-size companies. The loans are generally just a few years in duration and pay an annual yield of about 10 percent. The risk is in the credit quality of the borrower.
Mr. Taback of Wells Fargo Private Bank said that although there was credit risk in the loans, private debt does not feel the same impact that bond portfolios do when interest rates rise. “Now that you’re seeing losses in bond portfolios, clients are more receptive to this,” he said.
Find alternative strategies. Alternative investments are the province of investors who are willing to sacrifice access to their money for higher returns. But when markets were posting double-digit gains, they became less attractive.
Hedge funds, in particular, earned a bad reputation for the high fees they charge to manage money on top of taking a share of any profits. Some sophisticated institutional managers, like the California Public Employees’ Retirement System, announced in 2014 that it was getting out of hedge funds because they were too expense and complex.
But financial advisers and money managers are arguing that in a volatile investing environment, investors should reconsider hedge funds and other alternative assets like private equity, private debt and real estate. Their returns, they say, are less correlated to the fluctuations of the stock and bond markets and thus provide a steadying force.
“Last year, you could ignore risk and focus on return,” said Jae Yoon, chief investment officer of New York Life Investment Management. “This year, we’re getting more normal volatility, and most clients will find they don’t have enough alternative strategies.”
Go global. In Europe and Japan, the economic recovery started later and, the thinking goes, still has years to run. In some cases, the recoveries in Europe and Japan started in 2014, as opposed to 2009 in the United States, said Darrell L. Cronk, president of the Wells Fargo Investment Institute.
He said the strong rally in the United States markets had many investors with overweight investments in American stocks, a phenomenon known as home-country bias.
But since last year, many developed and emerging markets have begun to perform strongly. “The more explosive growth is happening in the younger economies around the world,” said Rick Pitcairn, chief investment officer of Pitcairn, an investment adviser to wealthy families.
Enjoy the ride. Once markets become volatile, they tend to stay that way for a while. It’s a shift in investor sentiment.
“There’s persistence in volatility,” Mr. Kinniry said.
But volatility is not necessary a bad thing when you have a plan. Mr. Cronk pointed out that even big corrections were a normal part of an economic cycle.
The last two economic recovery cycles, in the 1990s and the 2000s, had three corrections apiece toward the end, he said. Investors who bailed after the first correction in each recovery missed out because the markets rose 20 percent afterward.
“Corrections are normal and healthy,” Mr. Cronk said. “Investors should look at them opportunistically more so than be afraid of them.”
