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- Change in styles to calm nerves
Even though it didn’t take markets long to start recovering, the turbulence at the beginning of the month is likely to have shaken some investors’ nerves. Not only because some price movements (especially of Japanese assets) were of historic dimensions, but also because of the inconsistent overall picture. An extreme increase in the volatility of the stock markets was countered by a relatively restrained price reaction of corporate bonds.[1] While gold reached new highs, oil traded in a relatively narrow range despite the risk of escalation in the Middle East. Government bond holders were all the more nervous. They briefly priced in the expectation that the Federal Reserve (Fed) would react with a 50 basis point interest rate cut in September.
Of course, investors are searching for the causes of the market correction. Perhaps some are now beginning to doubt the profit forecasts. According to Bloomberg, the consensus believes that the companies in the S&P 500 could achieve double-digit profit growth in the second half of the year (compared to the previous year).[2]
Relative performance of Quality vs Minimum Volatility and Growth vs Value
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 8/13/24
* MSCI World Quality Total Return Index
** MSCI World Minimum Volatility Total Return Index
*** MSCI World Growth Total Return Index
**** MSCI World Value Total Return Index
But investors cannot be blamed for deciding to take a little risk out of their portfolios in order to avoid future stress before the causes of the correction have been fully explained. For example by increasing diversification, as the classic investment diversification worked again: bond prices rose when equities fell. But equity portfolios themselves can also be diversified more broadly. Not only by increasing the proportion of defensive stocks, but also by reducing the proportion of technology stocks, which have dominated markets so far. We did this in our multi-asset model portfolio at the beginning of July, when we switched from the "quality" factor to the "minimum volatility" factor (see our study "Time for a change of style"[3]). The index provider MSCI distinguishes between seven factors (or investment styles). Over the past twelve months, "growth" and "quality" have performed best. However, they are heavily dominated by the large technology stocks. In the quality index, for example, the ten largest stocks account for 38% of the index market capitalisation. In the minimum volatility index, on the other hand, this number is only 15%. As our chart of the week shows, the quality index has beaten minimum volatility (Min-Vol) since November 2023 (just as growth has outperformed value), but after the stock market highs at the beginning of July, Min-Vol was able to play out its defensive strengths. We currently see no reason to deviate from this strategy, as we expect markets to remain nervous until a clearer picture emerges of the U.S. economy and the ability of the IT sector to monetise the Artificial Intelligence (AI) boom.
