Tags: volatile | year | Panic

Another Volatile Year Looms, but Don't Panic

Wednesday, 14 Dec 2011 09:31 AM

 

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The looming New Year may well bring as much financial turbulence as tumultuous 2011 but global investors reckon "panic" is no longer an option and just protecting your money will require taking on at least some risk.

For all this year's left-field shocks — the euro sovereign debt and banking minefield, an unprecedented U.S. credit rating warning, Japan's earthquake, the Arab Spring uprisings — investors have not gone to ground in quite the same way they did at the height of the credit implosion in 2007 and 2008.

That's not to say extreme "risk off" valuations that have seen top-rated government debt yields drop below equity dividend yields have not persisted and grown, even as sovereign bonds were deemed riskier and the AAA status of the United States and Germany have been threatened by credit-rating firms.

Rather this pricing has happened without the same sort of panicked market dislocation that saw a wholesale retreat from investable assets and dash for cash three years ago.

"It is frightening that these valuations can be reached in a cold and calculated manner. We have seen none of the previous panics, nor the correlations of almost all liquid and tradable assets in a scramble for cash," said Jim Wood-Smith, head of research at British wealth management firm Williams de Broe.

This shows investors need to remain invested even though nervous of macro-driven index volatility and the prospect of real losses in cash or sovereign debt over a protracted period.

It's one thing descending into the bunker to see out an air raid, it's quite another to live down there for a decade.

No Refuge in Money Funds

For all the stress, volatility and gloom, investors actually pulled more than $150 billion from cash-like money market funds in 2011, according to fund-tracker EPFR. Back in 2008, almost half a trillion dollars flooded to these funds but cumulative losses since early 2009 still stand at more than a trillion.

There are two main reasons why hunkering down in "safety" is no longer an option.

One is that most traditional havens are now almost certain to lose you money in real terms over time as inflation-adjusted yields on 10-year U.S., German and Britain government bonds — not to mention money market funds or short-term savings accounts — are all now deeply negative.

The second is the toxic mix of slow western growth, sovereign stress and high market volatility is not going to go away in a hurry and could well define the rest of the decade.

"We do not believe that interest rates will 'normalize' for years, possibly running into decades," said Wood-Smith at Williams de Broe.

As Standard Life Investments' Rod Paris told Reuters last week: "It's easy to be very risk averse and not deal with anyone or anything, but we have a business to run."

Even the optimists — who still see double digit global equity gains next year — acknowledge it will at least be bumpy.

There are ways to look at the euro zone's slow-motion crisis resolution as a glass half-full. It may be the start of a historic fiscal union that bequeaths a stronger, better-functioning currency area.

Yet with the price for austerity being paid in growth and France, Italy and Spain together needing to raise up to 17 billion euros ($22.06 billion) of new debt on average every week in 2012, there's clearly scope for accidents along the way.

Growth may be better in the United States, but a presidential election year brings its own stasis and longer-term control of the country's debt mountain remains unresolved. The emerging engines of China and the developing world are cooling fast and markets there have underperformed badly this year.

For the pessimists, of course, everything remains bleak.

Deutsche Bank credit strategists told clients on Monday that much of their 2012 outlook could be directly copied from last year's, hooked on fear of debt restructuring, default, haircuts, and the choice between fiscal euro union or extreme levels of money printing. "The one difference is that the stakes have become far higher 12 months on."

And so volatility, it would seem, remains the name of the game as fundamental valuations vie with "event risks" and recession risks spar with more government intervention. Stock market volatility captured by Wall Street's VIX index may not be near 2008 extremes, but it is remaining elevated for longer.

A poll of investors conducted by the Association of Investment Companies this week showed 96 percent expect another volatile year in 2012. However, 71 percent think that markets will ultimately go up.

When asked what gave them the greatest cause for optimism, 26 percent of managers are encouraged by strong company balance sheets. A further 26 percent believe equities still represent good value.

In a world where years of sovereign stress and negative real yields lie ahead, high-dividend blue chip stocks or high-grade corporate debt - ideally of companies with hefty emerging market exposure — remain many money managers' investments of choice.

Williams de Broe point out that despite high correlation of top stocks and the dominance of index-tracking and use of exchange-traded funds, the past 10 years was not so much a "lost decade" for equity if stocks were carefully selected.

Even though the FTSE 100 has lost more than 20 percent December 1999, more than 33 current FTSE stocks — including blue chips such as Unilever and Tesco — at least doubled over the same period.

"In order for portfolios to provide returns that are more than paltry, investors must take on greater risk at a time when the volatility of equity markets is highly likely to become ever greater," said Wood-Smith.

© 2014 Thomson/Reuters. All rights reserved.

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