Was Christmas peace the catalyst? The worst December since 1931 was followed by the best January in U.S. stock markets since 1987. Blessed is the investor who reacted fast enough – or who didn't react at all. Trying to explain such short-term market turbulence macroeconomically does not get you very far. Market technicians are puzzled, too, as investors hardly differentiated between stocks, bonds or commodities in the big sell-off, when normally they tend to correlate negatively with each other. Even geographically, the market correction had its surprising aspects. U.S. equities were down more than European ones while emerging markets were surprisingly robust. So much for the U.S. as the stable anchor.
The lack of direction may be a signal of what to expect in the current investment year. We expect high volatility but only meager returns. The reasons can quickly be laid out: valuations leave little room for upward movement; economic growth is there but not dynamic; earnings expectations may need to be revised further down; and economic policy-making is increasingly delivering short-term, sham solutions. In this environment the central banks, too, are uncertain about the longer-term path. The U.S. Federal Reserve (the Fed) is not the only one to describe its attitude as one of "data dependency." This may please investors for now if it means the Fed is turning away from monetary tightening. But in the medium term it means greater uncertainty, making it more difficult to plan ahead.
All this suggests that investors should aim for broad diversification of their investments. They should be ready for everything and defensive as well as offensive in order to be able to participate in opportunities while being adequately hedged against risks. They should also have the courage to take profits in timely fashion should the markets become euphoric. For there are enough positive developments to be confident. Rather than a recession, we expect economic improvement in the course of the year. Labor markets are stable, and emerging markets offer more light than shade. And some might judge the fact that central banks have become more dovish as positive, too. The thing is not to miss the opportunities because of the risks.
Stefan Kreuzkamp, Chief Investment Officer