You May Have Noticed...

Posted: September 8, 2015 | by: Thomas F. McKeon, CFA

That the markets have stumbled recently. A one-way market is lovely for portfolio values but an unsustainable circumstance.

 

This is hardly a surprise as the global equity markets, especially the US equity markets have had an extended rally with almost no meaningful pullbacks. Global equity markets, especially emerging markets and Chinese markets have been hit especially hard recently as the Chinese cope with a slowing economy.

After a more than six-year advance with little in the way of pullbacks (see the chart) the confluence of a slowing economy in China and the endlessly debated moment when the Federal Reserve finally raises interest rates are thought to be the proximate causes for recent market anxiety and declines. They may well be. It could also be the extended valuations of US stocks, the sputtering economy, or any number of things.

The point is this: markets will fluctuate around a long-term upward trajectory. Sometimes the fluctuations are more extreme and more frequent…sometimes less so. The longer the markets go without a healthy pullback, the more severe the pullback is likely to be. How long or deep the current stock market pullback will be is unknowable.

 

A Little Volatility is a Good Thing

The rules-based hedges we implement as single-market hedged strategies or as part of a full allocation become more valuable when market anxiety is elevated. The options we sell to hedge stock exposures are highly sensitive to investor fear and anxiety. As such, we collect more cash when selling the monthly hedges. And more cash means enhanced returns and mitigated downside risk. So we welcome periods of market anxiety as they create the conditions for the hedging component of our strategies to really add value.

 

Steady as She Goes….

We don’t foresee an extreme market selloff like the events of 2007 through 2009. We do believe that with the full valuations of US stock markets, forward returns will be muted. Collecting a cash flow from a monthly hedge—as we do—could well be the optimal investing strategy for an extended period. And market pullbacks create lower valuations which in turn set the stage for better future returns. So we encourage you to take the short-term volatility in stride and know that as a long-term investor, market volatility is your friend especially because we are permanent sellers of volatility, on your behalf.

 

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