Between late August and early October, volatility spiked to levels not seen since 2011 when Eurozone sovereign debt worries spilled over from Greece, Portugal and Ireland to Spain and Italy. Not even Bernanke’s announcement in May 2013 that the Fed was considering scaling back QE – which provoked the so-called “taper tantrum” – created so much volatility. There was one obvious common factor with 2011: the disappearance of the marginal buyer – one willing to enter the market at its new level. Why did this happen? Back in 1997, Paul Krugman wrote an interesting article where he outlined the behavioral habits of investors which he believed create market inefficiencies.1 Amongst these were the short-term orientation of investors (to meet their annual targets), their herd mentality (to minimize career risk) and the tendency to over-generalize and to “be trendy” (accept the fashionable prevailing analysis).
Of course, investors do not need to look hard to find issues that are of concern – whether they be Chinese growth, commodity prices or government debt levels. Policy dilemmas – be they on rate hiking, QE , renminbi flotation, oil production or refugees – also proliferate. But during September and early October economists were indeed a pessimistic herd. All news articles were negative on China and there were frequent complaints about market liquidity. This was accompanied by a tendency to over-generalize and to, in Krugman’s phrase, "be trendy". Short-termism also featured.
This can get too one-sided. It is time to apply a more balanced approach. China is still growing at a much faster rate than the developed economies, commodity prices are likely to have bottomed out, households are taking a more disciplined approach to debt, and Europe has so far survived its debt crisis. What can and what should investors do? The answers are old-fashioned. Ask yourself how much volatility and risk you can take and what return you are targeting. Diversify your portfolio. Go global. We believe that investors who spread their investments across a variety of asset classes, a range of sectors and several regions are best positioned to cope with the current volatility and reduce their sensitivity to the next downturn. Apply a more tactically focused but disciplined management style. As news turns less negative in the not-too-distant future, markets should start to benefit from the return of the marginal buyer.
Market volatility, as measured by the VIX , increased to five-year highs during September. But have fixed-income markets overreacted to global growth and policy concerns?