The stockmarket’s January blues appear to have continued into February, with volatility continuing.
A small rally in markets at the end of January appeared to have brought some relief to investors. The FTSE 100 closed on Friday 29 January at 6,083, over 7% higher than the 5,673 level it dropped to on 20 January.
However, Tuesday 2 February was a pretty horrible day, with the FTSE 100 off around 2.3% to not much more than 5,900.
Volatility is once more being partly driven by oil and commodities. BP announced a bigger than expected fall in earnings, recording a loss of $2.2bn in the fourth quarter of 2015. As a result its shares are down by more than 8% on the day.
The oil price was also down significantly, and other energy and mining stocks are down on the back of this and more downbeat data out of China’s manufacturing sector.
Long-time clients will know that we often see volatility in markets as opportunity. When markets dip we often use a small amount of cash to purchase an index tracking fund. As the market recovers we then sell again, banking a gain.
In 2015, we managed to bank two gains on such trades of typically more than 5% each, by buying at around the 6,000 mark and then selling when markets recovered.
Going into 2016, as markets again dropped back we bought again at roughly 5,960 for most clients. However, sentiment notably worsened in January on the back of some disappointing economic data. As a result, we have revised down our equity market views.
Previously, when markets were around 6,000 our outlook was very positive, expecting a strong rebound. We have revised this down to a “neutral” outlook. This is not pessimistic but simply that we think returns over 18 months will be in line with long term averages rather than significantly above average.
Given this changing view, we no longer felt that being overweight equity at the 6,000 level was appropriate. Instead, we would prefer to have a “neutral” equity holding. This means the percentage of a portfolio held in shares should be in line with our normal long term positioning rather than us having more equity than usual.
As markets drifted above 6,000 on Monday 1 February we therefore took the opportunity to sell one of our volatility trades earlier than originally planned. For most clients this resulted in a small gain. However, more importantly it also cuts risk and gives us cash to invest should markets drop back more significantly.
We also hold one other volatility trade that we purchased in June 2015 when markets initially started to stumble. When markets go back up we may also sell this trade a little early. At our target sale point this trade will still be showing a loss but overall our clients should see a positive effect on their portfolio from the volatility trading strategy as a whole.
Sometimes volatility is a time to increase risk in search of potential returns, and sometimes it is prudent to cut risk to protect portfolios. Sometimes the facts change. If they do so, then we are never too proud to change our minds.
I must repeat that our outlook for equities is still reasonably optimistic given current market levels. It is just that we don’t see the FTSE getting back close to 7,000 any time soon.
In the short term, we think that volatility is likely to persist and risks remain elevated. By making these changes, if markets drop back significantly we have the firepower to take advantage of renewed lows.
We also see opportunities in other asset classes, and are about to add another alternative equity fund into portfolios. The fund in question can potentially make money from a falling market as well as a rising one. We think such funds could be a good place to invest at present as they have multiple opportunities to make returns. They also can provide valuable diversification in portfolios, making returns at different times to equities funds. We will provide more details once we have placed the trades in portfolios.
This blog represents the opinions of Equilibrium investment management team. The commentary in no way constitutes a solicitation of investment advice and should not be relied upon in making investment decisions.