Warning: the lifeguard’s not on duty. Swim at your own risk.
That’s the way investment advisor Richard Bregman views today’s market. “If you go into the water, there might be riptides, sharks,” says the CEO of MJB Asset Management, a New York-based firm that manages a little over $100 million in assets. “I want to be hedging for the out-of-the-blue moment.”
Like September 11 in 2001. Or the near-crash of the United States’ financial services industry in 2008. Or perhaps the total collapse of the euro zone in 2011 or 2012.
Anyone with eyes and ears knows that these once-in-a-lifetime events seem to be happening with greater frequency these days. Things that aren’t supposed to happen are indeed happening, and the stock
market has whipsawed as a result. The crash of 2008 and 2009 led to the gold rush of 2010. Which in turn led to the peaks and valleys of 2011.
What will 2012 bring? Volatility seems a near-certainty. In fact, the market is more volatile today than it has been at any time over the last five decades. An advisor’s job today is not just “buy and hold” (or “buy and hope,” as Bregman likes to say) but to take an active role in managing his clients’ money. When dealing with volatility, that means widening the investment horizon with strategies that include managed futures funds and arbitrage, as well as commodity trend indexes and stakes in currencies and real estate.
The aim, says Bregman, is to embrace diversified strategies, not just diversified portfolios.
“If the goal of an advisor is to keep clients from making suboptimal decisions, then you want to take volatility out of the marketplace,” Bregman counsels. “If they don’t panic, you have a much better chance of adhering to your investment strategy.”
Just how volatile is today’s market? According to an analysis performed by the New York Times in October, the market is more volatile today than at any time since 1962. In today’s market, it is six times more likely for the price of stocks to fluctuate 4 percent or more during intraday trading sessions than it was in the four decades leading up to 2000. Looking at closing prices alone, the Times found that since 2010, some 30 percent of trading days were up or down more than 1 percent by the time the closing bell rang. That compares to 20 percent of such days in the 1990s. Andrew Lo, a professor of finance at the MIT Sloan School of Management, discovered that 10 of the biggest 20 daily surges and 11 of the largest 20 daily dives from 1980 to September 2011 have occurred in the last three years.
The VIX, the market volatility index established by the Chicago Board of Trade in 2003, stood at 27.80 at the beginning of December, above its historic average of around 20, but far below its peak of nearly 60 in October 2008.
The causes of this volatility are both apparent and hidden. The U.S. economy is still recovering from the shock of 2008. Electoral uncertainty and the fate of expiring tax cuts have also left investors guessing. Unemployment remains high and corporate leaders are having trouble gauging the price-conscious consumer. Worst of all, the world’s second largest trading block, the euro zone, is on the edge of collapse. While some argue it is too big to fail, others see unsustainable spending and unwillingness among political leaders to take the steps necessary to right Europe’s course.
And then there are the hidden factors. Nadia Papagiannis, director of alternative fund research at Morningstar in Chicago, points to high-volume traders as the source of much of today’s stock market volatility. In a late 2010 article appearing in Morningstar’s Alternative Investments Observer newsletter, Papagiannis noted that high-frequency traders, who use automated trading programs to trade in and out of securities in a nanosecond, now represent 60 percent of total U.S. stock-trading volume. One study pegged the profits of high-frequency traders at $21 billion to $25 billion in 2008. While some argue that the liquidity they provide can only help the markets, Papagiannis is not convinced. She points to “less-than-legitimate practices” among some of the traders that have caused average investors to lose their shirts.
“One such practice relates to trading ahead or front-running institutional investors for liquidity rebates provided by exchanges. Yet another involves ‘latency arbitrage,’ the ability of certain market participants to profit from the relatively slow quotation system informing the rest of the market,” Papagiannis writes. “Although the evidence of these practices is hard to ignore, the total impact on investors is difficult to quantify. Nevertheless, public confidence in the equity markets is eroding, and the SEC and industry participants should attempt to stamp out these manipulative practices before the damage is irreversible.”