An Expert’s Guide to Market Volatility

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Russ shares three themes that have emerged from his conversations with numerous clients following the market drama in recent weeks.

Recent market drama can be seen through multiple prisms. A cursory look at the performance of major U.S. averages reveals a modest correction in stocks with relatively little movement in interest rates.

That view, however, ignores a longer term, and brutal, bear market in emerging market equities and commodities. Furthermore, though Bloomberg data shows that developed market equities’ absolute declines fell short of a bear market, recent selling was in many ways unprecedented.

Markets went from complacency to panic in record time. The speed of both the decline and subsequent reversal pushed the VIX—one measure of market volatility—to its highest level on record, and it abruptly rose from 13 to more than 50 in a week, according to Bloomberg data.

Given the rapidity of this move and the signs that market volatility is here to stay, it’s worth taking stock of how clients are reacting. In recent weeks, I’ve had several dozen meetings and conversations with clients, during the course of which several consistent themes emerged.

Three Ways Investors are Reacting to Volatility

1. Uncertainty over the catalyst 

One common theme among investors: few feel they have a grasp on what really happened. Unlike previous selloffs—such as those sparked by the U.S. debt ceiling or numerous European woes—there was no clear catalyst for the late August, early September meltdown. While the media focused on China, everyone already knew that China’s growth was slowing. In addition, it’s hard to see how a modest depreciation of the yuan justified an evaporation of trillions of dollars in wealth. This uncertainty was only reinforced by the rapidity of stocks’ decline. Still, as I’ve been telling clients, regardless of what sparked the selloff, it’s important to keep it in perspective: market fundamentals generally remain solid.

2. Is it time to buy emerging market (EM) equities?

Other than commodities, EM equities have been one of the worst performing asset classes in 2015. The recent carnage has only added to their multi-year period of underperformance. As a result, EM stocks, as measured by the MSCI Emerging Markets Index, look fairly cheap on an absolute basis and very cheap relative to developed market equities, as measured by the MSCI World Index. With EM valuations at a significant discount and sentiment toward EM stocks extraordinarily negative, investors with a contrarian streak are wondering if it’s time to buy. My view: it depends. Selectivity in EMs is key. I like stocks in Asia (outside of China) as well as those in EM countries that have been embracing reforms, such as Mexico.

3. Are there any places left to find income?

According to Bloomberg data, bond yields are pretty much exactly where they started this year, while recent volatility has pushed back the likely timing of a Federal Reserve (Fed) rate hike. This environment only exacerbates a problem that investors have been struggling with since the financial crisis: Where can I find income? Most recently, with the energy sector singled out for special punishment, I’m getting a lot of questions about mid-stream Master Limited Partnerships (MLPs) as a source of yield. My answer: I see relative value in U.S. high yield, tax-exempt bonds, international dividend paying stocks and preferred stock.

But despite the damage to markets and confidence, the overall tone of most of my conversations has been cautiously positive. Investors are understandably nervous about the selloff, particularly given its speed and uncertain origin. Still, as the client questions above indicate, my read of sentiment is that, for now, more investors are looking to buy the dip rather than to lower risk. That’s probably the right move.

 

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock. He is a regular contributor to The Blog.

 

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