After seven years marked by only sporadic bouts of volatility, economic and geopolitical forces are converging to create the potential for higher levels of market volatility in 2017. The facts may be in the news, but clients may not be connecting world events to their own portfolios – and that’s where the real challenge may lie.
The knowns, the unknowns, and the potential for volatility
On the economic front, central bank monetary policies have kept volatility artificially low for close to a decade, but this now looks to be poised for a change, at least in the U.S. In late 2016, the Federal Reserve increased interest rates for only the second time since 2007 while signaling the possibility of subsequest rate hikes. Further interest rate increase could mean the potential for increased inflation and dispersion in the market.
Simply put: Volatility may actually be the byproduct of the market perception that central banks are no longer delivering the so-called Yellen/Bernanke “put option” on assets.
On the geopolitical side, a Trump presidency and the Brexit are emblematic of the forces of change that could contribute to heightened volatility. But these events do not mark the end of geopolitical volatility; they are more likely just the start. Still to come is the Italian referendum, in which a “no” vote on political reforms could fan the flames of an EU breakup. Then come elections in Germany and France, where populist sentiments are running high and could stoke the fire even higher. Beyond that, an election in Spain in June of 2016 and Britain’s plan for enacting Article 50 add to the uncertainty in Europe.
Investor perceptions and the fear of volatility
Volatility is not a negative in and of itself. In fact, we believe it is essential to creating the dispersion needed to uncover value and opportunity in the markets. But many investors don’t always see it that way. Our 2016 Global Survey of Individual Investors1 shows that many investors believe volatility undermines their ability to achieve savings and investment goals. Over the past three years we’ve seen more and more individuals saying it’s most important for their investments to remain stable during volatile times.2 Knowing that many investors often define risk as losing their wealth, it’s no wonder that 82% of those surveyed say they will take safety over investment performance.
It’s this mindset that can lead to what advisors3 say is the number one mistake for investors: making emotional decisions. Unfortunately, investors may have a blind spot to this problem; 25% of investors surveyed in the U.S. think they could do better in their investment if they stopped making emotional decisions.
Managing the risks
For advisors worried about clients’ emotional decisions leading to negative outcomes, a two-pronged approach may be necessary to help keep clients on track.
First, we suggest taking the time to reeducate clients on risk, volatility, and their investments. Keeping them informed about what’s happening in the market is one thing; helping them understand what it means for them is another.
Second, consider examining risk exposures within portfolios. Analysis of our Portfolio Clarity Moderate Portfolio U.S. Peer Group4 demonstrates that as the markets have presented limited volatility over the past three years, equity allocations within the group of moderate portfolios have increased to 53%. As a result, equity risk concentration has approached all-time highs, moving from 86% of overall risk in 2013 (when equity allocations averaged 43%) to more than 90% in 2016.
Putting the strategy to work
For those who believe macroeconomic forces have aligned to present the potential for more volatile markets in 2017, it may be time to adjust equity risk exposures and rethink how allocations to non-correlated asset classes are positioned.
More information on the latest market trends is available on our Latest Insights page.
1 Natixis 2016 Global Survey of Individual Investors
2 Data collected from Global Investor Surveys conducted in 2014, 2015 and 2016
3 Natixis 2016 Global Survey of Financial Advisors
4 U.S. Moderate peer group consists of 2377 portfolios submitted to PRCG from Jan 2013 to Sept 2016. Performance data shown represents past performance and is no guarantee of, and not necessarily indicative of, future results. Source: Natixis Global Asset Management Portfolio Research and Consulting Group.
This material is provided for informational purposes only and should not be construed as investment advice. The views and opinions expressed above may change based on market and other conditions. There can be no assurance that developments will transpire as forecasted.
Understanding current market conditions and what might be expected in the near term.
Understanding potential market trends in early 2017 requires a look at the market’s recent optimism.
During periods of market optimism, remaining mindful of risk is still important.