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Volatility Returns With Vigor

8 February 2014 in Trading Ideas

You don’t have to be that astute an investor to realize that 2014’s market bears little resemblance to 2013’s market.

For starters, after rising by about 30% last year, the S&P 500 has already given nearly 20% of that gain back. Before Tuesday’s mini-rally, stocks had retreated to their lowest levels since the middle of last October.

But it’s not just that the market has lost some ground. We’ve also seen the return of choppy trading – and a rise in levels of volatility.

The Volatility Index recently surged to a high not seen since June 2013.

The market’s early wild ride has issued a challenge to portfolio managers and other investors as to how to proceed in 2014. As Robert Smith, chief investment officer at Sage Advisory Services, recently told the Wall Street Journal, the market may gain “8% or 10%, but it’s going to be a hard 8% or 10%. Investors are going to have to be really careful.”1

For many investors watching the market rock and roll in the first five weeks, the decision has been easy – it’s time to play defense. That has many portfolio managers shifting away from the kinds of investments that did exceptionally well in 2013 but are vulnerable to large swings.

low beta motifSpecifically, that has seen some investors trimming positions in US small-company stocks in favor of shares of large companies with growing dividends. Others are focusing on shorter-term bonds due to expectations that stronger economic output will lead to rising interest rates.

As the Journal noted, many investors see the Fed’s decision to begin tapering its asset-purchase program as a key reason for the recent chaos. That move, they say, has reduced demand for some assets (witness the havoc to emerging-market stocks this year) which has combined with wild price swings.

Barry James, president of James Investment Research, told the Journal that he wouldn’t be surprised to see stocks fall 20% this year before finishing 2014 slightly higher. For James, part of the solution for this year is to load up on more stocks with strong earnings that are returning cash to shareholders through share buybacks and stock dividends.

Another alternative might be to consider stocks that have tended to be less volatile than the broader market. This volatility risk measurement, called beta, can be part of a strategy that attempts to mitigate downside when the rest of the market is swinging wildly.

That is the very thesis behind the Low Beta motif, which is made up of a portfolio of 20 stocks which, over a five-year period, have shown lower volatility swings in comparision to the broader market. The Low Beta motif is down 0.9% in the past month. The S&P 500 is down 3.3% in that same time frame.

In the past 12 months, the motif has gained 10.4%. The S&P 500 has risen 19.3%.

1Tom Lauricella, Kaitlyn Kiernan and Katy Burne, “Stock Investors Brace for a Bumpy Ride,” WSJ.com, Feb. 2, 2014.

Tags: low beta