Market volatility leaves little room for romance
During television’s “awards” season, I always seem to find a stand-out moment in the Oscars that makes the whole slog worthwhile. This year, for me it was Lady Gaga’s tribute to Julie Andrews, reprising of the anthems of The Sound of Music, on the occasion of the film’s 50th birthday.
When she sang “I am 16 going on 17” the only thing I could think was, “Wow, she’s talking about the stock market!” Let me explain.
You remember the scene: Rolf (officious, pubescent telegraph boy) and Liesl (rebellious, over-protected Von Trapp ingénue) are respectively 16 and 17. They are dancing in a pergola in a summer rain shower, enflamed in puppy love. He warbles, proprietarily, that she’s in for trouble: “You are 16 going on 17, baby it’s time to think. Better beware, be canny, be careful, baby you’re on the brink…”
It’s all too much for us to resist. Of course the viewer smirks – we know how little difference there really is between 16 and 17, or 17 and 18.
Similarly, in investing, when you are starting from a low base, small increases may look like big returns, but we all know that is rarely the case. Last year I likened the volatile global equity market to a promising (but petulant) teenager. Since then, the U.S. equity markets appear to have graduated from “16” to “17” and may even be flirting with “18.”
At Russell Investments, our view of the U.S. equity market has morphed from a tentative ascent amid a fragile global economic recovery, to a more mature and sure-footed climb, corresponding to the efficacious application of the U.S. Federal Reserve (the Fed) stimulus. We now consider that the U.S. stock market is probably closer to its peak in the current business cycle, and we cautiously anticipate the last act in the Fed’s ongoing play, as noted in our latest 2015 Global Outlook Q2 Update: raising the Fed’s target interest rate to get the stimulus genie back in his bottle (probably this September). The U.S. is possibly starting to outgrow some of its past market volatility.
We anticipate a passing of the market leadership baton from the U.S. to Europe and Asia (especially Japan) for one of the same reasons we see equity prices cooling here in the U.S. The Fed’s stimulus program has been the familiar face of expansionary monetary policy; yet while it is coming to a close in the U.S., such programs are continuing to ramp up in Japan and Europe. The Bank of Japan and the European Central Bank initiated their stimulus playbook sequentially after ours. Because they are earlier in their cycles, they have more room to run.
However, if reading the future were this easy, we could just tell our clients to trade U.S. stocks in for non-U.S. counterparts. But it’s never that easy. Geopolitical unrest, currency swings, oil price movements – these are among the factors causing our adolescent global recovery to take a line that is far from predictable.
At this stage, we believe in staying diversified, and in making modest tactical adjustments around our core positions such that we might benefit a bit by being right, but not get blown up by being all wrong!
For two years many of us in the industry have been gradually preparing for the inevitability of rising interest rates-- gradually building positions to diversify the risk that rising rates could topple the benefits of our client’s bond holdings. We also have been diversifying into non-U.S. bonds, adding new types of fixed income strategies that are historically less sensitive to interest rate changes.
This no time to grow overly smitten with any single infatuation. In this climate, a little “older and wiser” can go a long way. Better to simmer down, get in out of the rain and enjoy the cover of a cozy pergola.