Nifty moves pave way for safe return
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Volatility is set to hit the markets, but investors can safeguard growth by diversifying, boosting exposure to the long-term story of emerging markets and keeping faith in a global recovery.
Oliver Sonnbichler is a fund of funds manager at F&C
The financial markets made a significant and highly-correlated recovery during the final six months of 2009. While this was positive news, investors are wary of the pace at which asset prices recovered. They are also suspicious about why the strength of the recovery does not reflect the unrelenting negative economic views in the general marketplace.
The wind will be at our backs for the next four to six months. The reflation of asset prices looks set to continue in the first quarter, perhaps even into the second quarter, and investors should try to hold their nerve and stay invested.
”Investors can adopt a range of strategies to ensure the impact on returns is reduced”
There is likely to be sufficient positive data to maintain the momentum–strong post-Christmas results, slowing unemployment levels, improving economic data–to support the recovery, while sufficient liquidity and investor appetite will drive asset prices higher. Nevertheless, there has already been a large increase in equity prices and even more in emerging markets.
At some point during 2010, central banks will need to shift their monetary policies. While investors remain nervous about this change, it is likely the central banks will signal their decision in advance to avoid any nasty surprises. (article continues below)
A globally co-ordinated approach from central banks to remove stimulus–withdrawing the additional liquidity provided so far–should offer stability but also ensure the process takes time and interest rates will remain low for longer. Realistically, it is unlikely that central banks will achieve a smooth removal of the stimulus and are therefore unlikely to meet market expectations.
Paradoxically, the risk has shifted to the upside–away from economic data being poor, and rather that it is much stronger than expected. If the market remains strong and economic data continues to surprise on the upside, this will raise the fear of inflation and spook the markets–especially if they have not seen any withdrawal of stimulus.
This may force the central banks into removing low interest rate policy before they are ready to do so. Once the central banks are perceived by the market to be behind the curve, volatility will return to the market.
This increased volatility will be negative for most financial instruments, although interest rate-sensitive credit instruments are likely to be the most affected and investors should aim to reduce as much of this exposure as possible. Investors can adopt a range of strategies to ensure the impact on returns is reduced, such as investing in property, where the yield is not dependent on interest rates and where many predict a substantial capital recovery during 2010. Another possibility is mortgage-backed securities, which as floating rate notes are not affected by increases in interest rates. Structured products will also have a role to play and investors should explore instruments that will benefit from a pick-up in volatility.
In terms of equities, the appropriate strategy would be to remain exposed to the growth prospects offered by a recovering global economy, but to retain some diversification. It is possible that growth and profitability will continue to surprise in the early part of the year, and investors should focus on the faster-growing parts of the equity spectrum to benefit from any good news.
Investors should, however, maintain a barbell approach to their equity holdings to benefit from two key growth themes. First, the emerging “New Nifty 50”–companies in developed markets which are able to build on their brand, balance sheets and scale to gain significant market share as their competitors fail–and, second, strategies that are geared to the growth of emerging markets. A barbell approach should offer diversification while investors remain exposed to growth.
Investors should try not to become too preoccupied with any potential reversal and expect a bumpy ride from the summer. Surprisingly, the risk for investors in 2010 is not that there will be a massive reversal.
The greater risk is that investors are not part of the recovery and will therefore miss out again on the opportunities that excess liquidity is providing to the market.
While a spike in volatility is expected in 2010, this is unlikely to halt the underlying economic recovery or stall growth in the emerging markets. There may be a correction in both bond and equity markets, but the long-term trend still looks positive–particularly for equities, given their reasonable valuation levels. Investors should stay invested but seek strategies that can either eliminate some of this volatility, or perhaps benefit from the increase in volatility.
