As equities dramatically collapsed last week we are asking ourselves whether this is going to be structural or whether we can expect a reflation of prices, as it appears to be another sentiment driven collapse.
At best, the start of 2016 has been messy and is a continuation of the increased market volatility brought on largely by the Federal Reserve’s move to raised interest rates last month.
All of the main stock markets are now seeing volatility approaching three-year highs but are showing no signs of approaching the equity bubbles of 2008/09 and 2002/03. While we’re not seeing a bubble that is about to collapse imminently, we’re also not quite out of the woods and 2016 will bring its challenges.
So in the short term, certainly, it appears that although we are seeing increased risk, the fall experienced last week and this week was driven by sentiment and not a structural change in the economic outlook.
We would expect by the end of January (subject to continued positive data out of China) all indices will be in positive territory and we have already seen sentiment change and momentum twist to the upside in the very short term.
Having seen little or no change in the past few months in our macro model, we think to sell out of current portfolio holdings on a downward trend driven by sentiment, that can reverse as quickly as it has formed, would be unnecessary and fool hardy.
Towards the end of 2015 it seems that bonds and many bond proxies were not doing what they were meant to in that they were offering lower than expected returns with higher than expected volatility.
Although that in itself is not a significant problem, coupled with the increased volatility, frequency of market declines and swinging sentiment, not to mention the start of some market liquidity issues, the sector is unlikely to provide significant risk rewarded returns in 2016. So taking directional positions either way in 2016 with so many roadblocks and potential car crashes ahead, is a concern.
Poised for a reposition
Should the macro environment change to substantiate that the current drop in equities will become structural and therefore not a short-term dip based on sentiment, we are poised and ready to reposition our portfolios across the board.
This repositioning is intended to make them less directional either way, in the current environment and make use of fund managers that can take positions both long and short in UK, Europe and Global sectors.
We’ll look to use two types of products: those that have volatility akin to corporate bonds (as these are no longer viable due to lacking liquidity and increased risk) and those that have higher levels of volatility but only half of that which is normally associated with directional equity funds.
We are also directionally increasing the non-equity percentage on all portfolios effectively taking more risk off the table. The resultant models will therefore have half the volatility of the current portfolios and be positioned to provide returns directionally in line with the outcomes, whichever way the market decides to go throughout the coming year.
We intend to use these new portfolios when we feel the market move to the upside outweighs the risks to the downside.
Jason Stather-Lodge is CEO of OCM Wealth Management.