Volatility is here to stay, so how will you manage it?
That was a key message at Legg Mason Canada’s Global Investment Forum, held on Sept. 29, 2011, in Toronto. Timothy Schuler, senior vice-president and investment strategist with Permal, discussed the factors influencing world markets today and what portfolio managers are doing to mitigate the associated volatility.
Looking back, 2008 was predominantly a problem of credit, Schuler explained, which led to governments taking extreme measures to keep the banking system afloat. However, further financial stimulus won’t solve the larger problem. “Unless there is an intergalactic bailout that we are not aware of, somebody’s eventually going to have to pay the bill,” he joked. “And that’s where we are at the moment.”
Despite the fact that central banks around the world have been injecting large sums into the economy, it hasn’t achieved the desired effect of increasing inflationary pressure and boosting the economy. “Credit is being destroyed faster than money is being created,” Schuler said, adding that “credit always leads the equity market.”
How do you solve a problem like Greece?
Much of the volatility that markets are currently experiencing stems from sovereign debt issues in Europe. “Greece, in many ways, is like subprime but for the sovereign market,” Schuler noted, in that despite its relatively small status on the world stage, it still has the potential to bring down world banking systems.
Markets are interconnected and highly correlated, he continued, and this interconnectivity has grown even stronger due to the events of 2008 and as a result of the policy decisions that governments made to try to “keep the stability of the world intact.” As the debtor, Greece is “essentially holding the rest of Europe hostage,” Schuler explained. “So this is why we’ve seen such volatility in the markets, and I don’t anticipate that volatility dissipating any time soon.”
Defensive tactics
How are portfolio managers responding to the bad news? Schuler said “the front page of the newspaper is driving decisions more than the business section,” so portfolios are moving to a more tactical, global macro approach. He’s seeing more exposure in credit, fixed income and currency, with minimal exposure to equities.
With low consumer confidence and subdued expected growth in developed markets, managers are cautious, and portfolios will likely stay on the defensive until the outlook improves, Schuler added. For the near term, at least, investors are in for a bumpy ride. “The headlines are going to drive market behaviour, clearly—and those headlines are going to be in many ways efforts to kick the can rather than deal with the problem.”