Stocks have rebounded nicely since the heavy selling in early February, recently enjoying their biggest weekly gain in five years. But last Wednesday's see-saw action following the release of minutes from the latest Federal Reserve meeting was a reminder things are likely to stay shaky for some time yet.
The S&P 500 initially spiked higher, taking succour from the Fed's upbeat take on the economy, before renewed uncertainty surrounding the effect of increased rate hikes and rising bond yields – 10-year US yields almost touched the much-watched 3 per cent level for the first time in four years – catalysed a sharp U-turn. Yields between 2 and 3 per cent represent the "sweet spot" for stocks, Merrill Lynch cautioned in a report last week. Art Cashin of UBS went further, referring to fears that "all hell will break loose" if yields top 3 per cent. That's hyperbole – there is, as Merrill put it, "no magic number".
Still, it's reasonable to assume last year's abnormally low volatility is not returning any time soon. As Ritholtz Wealth Management's Michael Batnick points out, volatility tends to cluster. Things can be quiet for years, but when volatility eventually erupts, it sticks around for a while. Large price changes follow large price changes, says Batnick. "Nobody knows when or how or why stocks will return to a period of small changes, but it's very clear what sort of regime we're in today."
Should traders catch the falling knife?
Amateur traders might be wondering how best to handle the recent volatility. Should you buy on weakness? Or should you wait for the dust to settle before diving back into stocks? Many think it’s too dangerous to catch a falling knife, but the evidence suggests otherwise, says PastStat blogger and quantitative trader Kora Reddy.
He tested the profitability of two simple trading strategies. The first bought the S&P 500 when the index closed below its 50-day moving average (DMA) and exited when it crossed above its 50-DMA; the second strategy did the opposite, buying when the index crossed back above its 50-DMA and exiting when it closed below its 50-DMA.
Since 2000, you’d have bagged roughly 80 per cent of all market gains by adopting the “buy low” strategy, even though you’d only have been invested one-third of the time. In other words, the “buy low” strategy generated average daily returns almost eight times greater than the trend-following approach. Disciplined traders should not be afraid to “go aggressive”, says Reddy.
As for investors looking to build long-term wealth, his advice is simple: “for heaven’s sake, do not get out of the market” at the first hint of weakness.
Investing apps can be dangerous
A piece of friendly advice – if you have an investing app on your smartphone, delete it. Heavy traffic from panicked customers resulted in website crashes and all kinds of technical difficulties at a variety of major financial firms, including Vanguard, Fidelity, Betterment, TD Ameritrade and Schwab, earlier this month. TD Ameritrade reported "unprecedented client activity", although the outages weren't driven purely by hyperactive clients eager to trade.
Rather, many smartphone users were logging into their investment accounts to check their balances and to see what kind of damage had been inflicted. Firms like Vanguard and Betterment are primarily used by long-term investors looking to build up retirement accounts.
The problem, as Vanguard cautioned last week, is it's never been easier to get immediate market updates and to feel "impelled to act" when markets turn south. Research conducted by Nobel economist Richard Thaler confirms investors become much too cautious when they frequently check their portfolio. The best way to resist temptation is to avoid it; rather than relying on your willpower, just delete those apps.
Forget bonds: buy wine
"Investments of passion" like wine, fine art, violins and stamps bring financial as well as emotional rewards, according to the latest Credit Suisse Global Investment Returns Yearbook.
The yearbook looks at data stretching back as far as 1900, making it the “broadest study ever published on the long-term rewards from private-wealth assets”. Over the entire period, the average collectible rose 30-fold in real terms, generating inflation-adjusted annual returns of 2.9 per cent.
Wine was the big winner, returning 3.7 per cent annually, although the returns from art (1.9 per cent) were more psychic than financial. Unsurprisingly, global stocks did better, generating annual real returns of 5.2 per cent, but collectors won’t be disappointed by the data. Firstly, collectibles delivered better annual returns than bonds (2 per cent) over the last 118 years.
Secondly, owners typically hold such assets for generations and only pay tax when selling. This tax saving, the yearbook estimates, means they actually outperformed British equities over the last century. Finally, there is the “emotional dividend”. Mind you, you could argue stocks bring more excitement than stamps, but each to their own.
