Stocktake

Correction or not, investors may need to “buckle up for more volatility” following the recent “market rout”, Blackrock recently cautioned.

Two points: One, since when did a 1.2 per cent market fall become a “rout”?; Two, should investors, as opposed to traders, care?

No, says Barclays's Dr Greg Davies. Volatility is "considerably less important than we think it is", says Davies, a behavioural finance expert. Low volatility may well indicate markets are complacent about short-term prospects, but it says "almost nothing about the long-term value of being invested".

The danger, he says, is that people believe the talking heads and see low volatility as a “harbinger of catastrophe”, thereby remaining uninvested.

“Having run out of excuses not to invest from high volatility and recent bad times, you may now find excuses from low volatility and good times”.

Long-term returns are not endangered by volatility, says Davies, but by the fear of volatility.

Is volatility returning to the markets?

With the escalation of tensions in Ukraine and Gaza triggering market jitters, investors are wondering: is volatility back?

The Vix, or fear index, soared recently, rising 32 per cent in a single day – its biggest one-day rise in 15 months and the 22nd-largest since 1990.

Such rises have historically been followed by below-par performance, with a number of market sell-offs occurring.

However, markets are calmer than it may appear. The Vix was rising off a very low base, having been resting at seven-year lows.

Its recent peak – a reading of 14 – remained way below its historical average of 20, and nowhere near levels registered in market panics.

Volatility spikes are less noteworthy when the Vix is below 20, Bespoke Investment Group finding eight such occurrences over the last 24 years.

Three months later, markets were higher on six occasions, with returns little different to normal three-month periods.

Everyone is waiting for a correction, but recent market action is less ominous than it seems.

Corrections are less painful than imagined

I noted recently that although it’s been more than 1,000 days since stocks suffered a double-digit percentage decline – more than twice as long as average – it’s naive to assume a sell-off is inevitable. Still, with so many agonising about the possibility of an overdue correction, it’s worth asking how bad such a sell-off might be.

Money manager and blogger Ben Carlson examined nine other periods where stocks went long periods without correcting.

Only twice – in 1987 and 2007 – did bear markets follow.

The longest winning streak, the seven-year run between 1990 and 1997, was followed by a minor 11 per cent correction. On the other six occasions, stocks fell by amounts ranging from 10 to 16 per cent, with a median sell-off of 14 per cent.

That’s hardly heart-stopping stuff. And yet, the fear of such sell-offs has caused many investors to remain on the sidelines over the past five years, during which time stocks tripled. To borrow from Greg Davies, the fear of the sell-off is more damaging than the sell-off itself.

Markets laugh off short seller’s tears

One should probably not pity a billionaire, but it was hard not to feel sorry for hedge fund manager Bill Ackman last week.

Ackman, who has lost hundreds of millions of dollars since 2012 shorting multi-level marketing company Herbalife, announced last Monday he would publicise his findings into Enron-like fraud at the company. He would "annihilate" Herbalife in "the most important presentation of my career".

Investors believed him – Herbalife shares plunged 11 per cent. On Tuesday, thousands tuned in to watch his three-hour presentation, including Ackman's father. Herbalife was a pyramid scheme and "criminal enterprise", its chief executive a "predator". Towards the end, Ackman, who has described his crusade as a "patriotic short", choked up as he recounted his own family's immigrant journey from Russia to the US, and how Herbalife was exploiting the poor, selling a fictitious American dream.

Investors didn’t cry, however – they laughed, Herbalife shares soaring 25 per cent. Ouch.

Markets to hit bubble territory?

Legendary value investor Jeremy Grantham reckons the current rally has some room to run, but will eventually – like in 2000 and 2007 – be followed by another market crash.

In his latest quarterly client letter, Grantham notes the “veritable explosion” in financial deals. Far from marking a market top, he predicts “all previous deal records will be broken in the next year or two”, mainly due to record low interest rates, continued high profit margins and the “early-cycle look” about the US economy.

Today, US markets are pricey but not bubbly, he says. However, Grantham, long a critic of the Federal Reserve’s easy money policies, says very low rates will only encourage extreme speculation, improving the odds of a “fully-fledged equity bubble before this current episode ends”.