Commentator – Geoff Wood, Head of Macro & Risk
Q1: What’s driving the recent market volatility?
In early December the market was concerned by three fears, two of which have receded materially in our view
1. Global growth weakening
The most substantial risk for markets as there is no easy fix. Many global growth indicators have slowed and the US which has the strongest growth momentum is likely to recede as the Trump led fiscal pulse wanes and the monetary tightening continues to push through the system.
2. China/US trade talks
While we had neither resolution nor escalation in December, the Trump/Xi relationship was fortified. We believe the arrest of the CFO for Huawei was an unfortunate coincidence in timing and not part of the larger tariff debate.
3. Fed being too hawkish
Fed Chair Powell’s comment in early October that the Fed are “a long way from neutral” led to the break high in bond yields that rang the bell on the Equities and marked the highs for markets in 2018.
Q2: How long do you think it will continue? Why?
December’s volatility is unlikely to be repeated in the short term. However in the later stages of bull markets it is not uncommon to see more gyrations in markets like December. The reason being that more hot money pours in to markets at this stage which can be destabilising as it is quick to sell on any weakness. Fundamentally the Fed have changed stance since October and the trade negotiations are on track for a deal. Global growth is still under question though. US data such as retail sales and Industrial production is weak and needs to be watched carefully. Chinese stimulus, however, is picking up and seen as a source of optimism for Asia. Many active managers moved portfolios to very bearish positioning in December and are now being forced back into the market as their interpretation of events was misplaced which has led to a huge rally off the lows.
Q3: Is volatility – especially if it is sustained – better for active management strategies rather than passive? Why
Volatility provides active managers the opportunity to both out perform and underperform a market. For good managers it is a chance to differentiate themselves from others. Passive funds are only passive if they are not traded actively by the underlying customer. Much research however shows that passive funds are indeed traded and the behavioral bias of humans is unfortunately to buy high and sell low. Having a long-term strategy in place can help retail customers avoid this bias.
Q4: How does your investment process define and manage volatility?
Morphic’s philosophy is that over the long run equity markets provide investors with good returns and thus the portfolio is generally fully invested. In times when Morphic deems it prudent it will hedge the portfolio against a falling market. This reduces the portfolios overall volatility. All investments held in the portfolio have their volatility examined and this feeds into the portfolio construction process. At its simplest more volatile positions are generally a smaller weight in the fund.