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Volatility Wastes No Time in 2016

5 January 2016 in Trading Ideas

For those who follow this sort of thing, it came down to the year’s final trading day as to whether the S&P 500 would finish in the black or the red for 2015 (total return with dividends, however, was already assured of a positive finish).

In the end, stocks came up just short, finishing down 0.7% for the year, with total returns offering a tepid 1.4% yield.

By the end of 2016’s first trading day, though, this all seemed somewhat academic — the S&P 500 fell 1.53% out of the gate, pushing stocks to a 4% decline over the past month.

The move was sparked by a tumble early in Asian markets, which saw declines so steep in China that authorities halted all mainland trading before the end of the session.

As the Wall Street Journal explained, analysts cited a number of reasons for the selloff, including China’s disappointing manufacturing data that was reported earlier on Monday, and the coming removal of a ban on major shareholders from selling stakes that was put in place during the summer stock crash.1

Perhaps more importantly, Monday’s plunge came just three weeks after stocks had plunged more than 2%, which at the time sent the Volatility Index (VIX) to its highest level since late September.

On Monday, the VIX again jumped well above its 200-day moving average.

The increasingly whipsaw pattern of stocks isn’t necessarily a short-term blip – this could very well be the landscape that investors are forced to navigate in 2016.

That’s certainly the view of Allianz chief economic adviser Mohamed El-Arian, who recently wrote that the return of market volatility shouldn’t be a big surprise, given the unusual economic, political and geopolitical fluidity around the world.

“The past year has been characterized by occasional spikes in volatility, either in the form of sharp asset-price gains or, as was the case last week, acute falls,” El-Erian wrote. “And 2016 promises a lot more of the same, which should force investors to pay greater attention to the dynamics of potential tipping points.”2

El-Erian said that the latest financial market instability was accentuated by the Federal Reserve’s recent decision to hike rates last month, which “confirmed the divergent monetary policies undertaken by the world’s most influential central banks.”

Also playing a role were concerns about market accidents following the news that at least two corporate bond funds had limited investor redemptions, according to El-Erian.

The Fed’s contribution to volatility also was cited in an article for Barron’s by Jared Woodard, an equity derivatives strategist who believes that the end of the monetary-easing regime by the Fed and the prospects of three or four additional rate increases next year, along with continued easing efforts in Europe and Japan, could create more selling pressure in domestic equities and risky fixed-income assets.3

In addition, Woodard thinks tight regulation and periods of poor liquidity could exacerbate ordinary market fluctuations with fewer “volatility sellers of last resort” waiting to step in, compared with the past several volatility regimes.

He also sees reduced demand in China and emerging markets combining with rising wages in the US to possibly send corporate profit margins lower, creating additional headwinds for stocks.

El-Erian, meanwhile, offered to CNBC viewers on Monday a broad prescription that traders will have to “learn how to play” sharp market moves, both upward and downward, stressing that they will need a “stomach for volatility.”4

But there’s another alternative: finding a group of stocks that have shown the tendency to contain volatility in a wildly swinging market. That’s the thesis behind the Low Beta motif, which could be an attractive part of your investing strategy in this new high-volatility environment.

The Low Beta motif has gained 4.3% in the past 12 months. In the past month, it’s down 2.1%.

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  1. Chao Deng, “China Stocks: Trading Halted for the Day as Circuit Breaker Kicks In,” wsj.com, Jan. 4, 2016.
  2. Mohamed A. El-Erian, “Nine Signposts for Navigating Market Volatility,” Bloomberg.com, Dec. 21, 2015, http://www.bloombergview.com/articles/2015-12-21/nine-signposts-for-navigating-market-volatility, (accessed Jan. 4, 2016).
  3. Jared Woodard, “Prepare for Rising Volatility in 2016,” barrons.com, Dec. 26, 2015.
  4. Jacob Pramuk, “El-Erian: 2016 will be all about volatility,” cnbc.com, Jan. 4, 2016, http://www.cnbc.com/2016/01/04/el-erian-2016-will-be-all-about-volatility.html