Last week we began a discussion on finding returns in this very challenging market. This week we’ll look at three major risks facing us today.
I believe the three most important financial issues of the day are Greece, China and the massive amount of global debt. As you probably know, the voters in Greece rejected an offer that would have brought more financial relief along with austerity requirements. Greece’s “no” vote raises the possibility that it may exit the eurozone. This also raises the level of uncertainty in the financial markets. Perhaps the more important issue is the powder keg that exists in Spain, Italy and Portugal. Surprisingly, despite all of the known issues, the Athens Stock Exchange is down only 2.28% this year. However, during the past 12 months it’s down 29.92%. Clearly, this is an issue to monitor.
From Jan. 1 through April 27, while U.S. stocks were struggling to stay in positive territory, the Alpha Shares China All Cap Index rose 24%. After such a meteoric rise, the index collapsed, and by July 8,it was at -6.67%. China was officially in a bear market. Two days later it rose nearly 8% to its present level of 1.29%. But the real story is the spike in volatility.
On March 16, 2011, the Chicago Board Options Exchange (source of the VIX) introduced six volatility indexes, including one that tracks Chinese stocks. As of July 10, the Chinese VIX was at 38.91. This is above its historical average of 26.70, but below its peak of 63.42. Volatility in the Chinese stock market as measured by the Chinese VIX has risen by 50% in 2015. Chinese stocks have been fluctuating tremendously on an intraday basis. Although volatility has fallen over 15% since July 8, it still bears watching with a cautious paradigm.
When you consider all of the issues facing us today, global debt may be the most serious. To paraphrase Ray Dalio, founder of Bridgewater Associates, economic growth is all about spending. Because debt was such a large driver of economic growth during the two-and-a-half decades leading up to the 2008 crisis, it’s going to take time for the economy to normalize. Now that the debt party has ended, we are living in the hangover period where more money is required to repay the debt, which leaves less to spend. This is a key reason for the sluggish U.S. economy. Globally, the amount of debt is staggering, which may help explain why economic growth has been so stagnant in most of the developed world.
The Hunt for Returns
Where can investors find returns? With stocks, bonds and cash, only stocks have the potential for strong returns in the near term. However, in the wake of a seven-year U.S. bull market, there is also considerable risk. Hence, it may be wise to invest in specific regions, countries or even sectors. For example, the best sector in the U.S. has been health care, up more than 17% year to date. The next best sectors are consumer cyclical and financial stocks, sporting returns of 5.55% and 3.96% respectively. The best regions/countries have been Japan and Europe. However, both have shown signs of weakness.
Personally, I am looking for sectors and regions that have been beaten down using ETFs and individual stocks. It’s easy to buy low. However, as Yogi Berra once quipped, “It’s tough to make predictions, especially about the future.” He also said he doesn’t buy a stock unless it goes up (paraphrased).
Whatever you choose, it’s important to protect the riskier assets with options, stops or other prudent devices. When the next crisis comes, you do not want to have to inform a client that their portfolio has dropped by 20% or 30% or more. To borrow a phrase from the old TV show Hill Street Blues, “Let’s be careful out there.”
Thanks for reading and have a great week!