Around 80% of the time markets and stocks actually move nowhere. They gyrate and consolidate and when they do rise or fall to new highs or lows, it actually occurs in a very small window of time. Take a look at any stock or index and you will see that the vast number of time spent doing nothing. One of the factors that contribute to this is seasonal. The old saying is “Sell in May and Go Away” and as we approach this typically weak period (or at the very least a period with no direction at all), markets have enjoyed a strong comeback from the dismal start to the year.
Volatility in equity markets tends to reach its lowest point in May and then generally start to rise thereafter and if there are major corrections in the offing, they almost always come in the August – September period.
Below is a chart of the Volatility Index (VIX) in the US with May highlighted every year by the vertical lines, for the past 10 years. There is a clear rise in volatility. Again look at where we are now and the low levels we are approaching in the VIX. This strongly suggests that in May investors should start to really reduce risk in the portfolio and begin to focus on capital preservation.
One problem I often have with just focusing on indices for developing whether to be long, short, neutral etc is that it can regularly mask what is actually unfolding behind the scenes with sectors and even individual stocks. Australia is one of the worst culprits for this because our index is dominated by just two large sectors – financials and resources. We are seeing some of this with the S&P 500 recently as well. Focus on the index too much and if you believe it has peaked or lacking direction and you will be psychologically inclined to not buy any stocks. This is far too one dimensional and I have witnessed even professionals miss out on returns.
A revival in commodities which have lagged for so long could easily continue to perform well and in fact I think they will. But that will also mean sectors and stocks that have benefited from low oil prices will begin to suffer – airlines – as their margins begin to contract once more. Delta Airlines, United Airlines, Qantas etc have all now passed the best cost side conditions. Any slip in demand like that seen in Qantas this week will have an amplified effect. Time to rotate out.
Another area investors need to be careful in the near-term with is property trusts, infrastructure and utilities. As commodity prices rise, minimum wages are lifted and employment levels are at near maximum levels – inflation has begun to pick up. This means higher short-term market interest rates. The problem though is that the global economy is weak and even in the US, the economy is patchy and a rise in short-term rates will increase the risk of a recession. Hence short-term rates rise faster than longer-term rates and the yield curve flattens.
The higher short-term rates aspect (whether it translates to the Fed raising rates or not in the next few months is irrelevant) will place pressure on the defensive high yielding sectors. The last two nights in the US the utilities index has fallen near 5%. It trades on earnings multiples of 17-18 times. The consumer staples index has also rolled over as shown below with some stocks within index like Colgate trading at 25x. Local property trusts are therefore vulnerable as well. The residential property market has peaked with an apartment oversupply looming, creating an uninviting recipe for new investment into such listed trusts at current prices.
What this all supports is that 2016 is about looking at the macro environment with a bearish tone and stock selection needs to be based on a greater bottom-up focus. Longevity in stocks trading at a premium to the market is unlikely to be sustainable and complacency is not something investors should allow to creep into their portfolios as we head into a typical period where volatility begins to rise.