Ariel Investments February 2016 Commentary
Lately people have been talking a lot about volatility in the stock market. Oftentimes when volatility is being discussed, the market is falling rather than rising. Strictly speaking, volatility addresses the “dispersion of returns,” or how much prices bounce around– whether up or down. It may surprise some that when standard monthly measurements are used, the broad markets have actually moved from a low level of volatility to a more normal level as returns have shifted to flat or down in recent months. The discussion of volatility does have merit—when using other measurements one can see why people are talking about it.
Odey's Brook Absolute Return Fund was up 10.25% for the third quarter, smashing the MSCI World's total return of 2.47% in sterling. In his third-quarter letter to investors, which was reviewed by ValueWalk, James Hanbury said the quarter's macro environment was not ideal for Brook Asset Management. Despite that, they saw positive contributions and alpha Read More
In the summer of 2014 equity markets slowed or reversed their climb and became more jumpy. That is, they shifted from really good returns and historically low volatility toward low or poor returns with historically standard volatility. The numbers are below.
As human beings, we feel this kind of shift negatively. Think of it in terms of the weather. Say it has been unseasonably warm with almost no rain before shifting to typical seasonal weather: cool and rainy. Many will feel it has become “very rainy,” even though it is simply normal. About a year and a half ago the market cooled, and in this metaphor volatility is like precipitation. Market volatility is fairly normal overall but feels high.
Ariel Investments – Day-to-day volatility in the stock market
This year there has been a lot of focus on day-to-day volatility, especially in the press. Financial news website Business Insider recently ran a story entitled: “The stock market is having one of its wildest years in history.” The article noted that, according to Bespoke Investment Group, for the first two months “there have been only 2 wilder years [than 2016]: 1932 and 2009.”1 That judgment comes from the fact that so far, 23 out of 39 trading days had a more than 1% movement up or down in the S&P 500 Index. There are more examples that support this view. In all twelve months of 2013 there were only two trading days where the S&P 500 fell more than -2%, and in 2014 there were four. In 2016, there have already been three in just two months. The flip side has been true as well: in 2016 we have seen two trading days of +2% gains—the same number for the full years of 2013 and 2014. So day-to-day volatility has been elevated to very high levels. Yet, overall, our reaction to this is that one day movements are not of great consequence.
What has mattered a great deal, on the other hand, is the type of stocks you happen to own. We have all read about the strong preference of supposedly “safe” stocks2. Across market cap ranges, we found the divergences between so-called safe stocks and the rest of the index were extreme. We use the S&P 500 over the last 19 months as a broad market proxy. The 10% of stocks with the highest beta scores—those that were the most jumpy—fell -10.55%; those with the lowest beta scores rose +19.76% (or nearly 10 times as much as the market!). Those in Standards & Poor’s top two quality tiers, A+ and A, climbed +10.20% and +15.65%, respectively. Meanwhile, those rated B- dropped -14.58% those rated C fell -29.43%. Finally, stocks with high dividends of more than 2.9% rose +9.30%; low-dividend stocks with dividends between 0.8% and 1.6% slid -2.46%. Surely companies with low beta scores, high quality ratings and high dividends are often the same, but the larger point is that those who did not fully embrace “safe” stocks likely saw poor returns. Also, several sectors were especially weak, with the energy area being by far the worst. Among our value benchmarks, the sector dropped -37.45% in large-caps, -61.03% in mid-caps, and -70.75% in smid-caps. Obviously that has been a harrowing ride.
Ariel Investments – Volatility will dampen soon
So we think three things are clear about current volatility levels. First, volatility has increased in the last year and a half. Second, it has not reached above-average levels using standard metrics. Third, if your portfolio has not leaned toward “safe” stocks, your portfolio likely has lagged and you probably feel the shift more and also more negatively. The good news comes from a contrarian knowledge of groupthink: once news articles start to focus on one apparent problem in the market, the market typically starts to change. In our view, it seems likely that volatility will dampen soon and that the fashion for supposedly safe stocks will turn and the sharp market divergences will soften. As always, we counsel patience.