PEOPLE often shun volatility because it evokes images of change, unpredictability and instability. As creatures of comfort, we relish stability. However, investors should view volatility more positively, as a volatile market offers many opportunities.
How do we describe volatility? Investment guru John Train defines it as “the degree to which a stock is buffeted up and down by buying or selling interest,” in his book, The Craft of Investing.
In Malaysia, there had been several volatile periods in the stock market over the last two decades, including the Black Monday of October 1987, the “super-bull run” in 1993 and the Asian financial crisis in 1997.
While the past two years had not been the most volatile experience, it had been unsettling for investors, as financial markets struggled with global economic uncertainties. Investors had to contend with attacks on the US in September 2001, the resulting war on terror, US corporate accounting scandals and continued sluggishness in global markets. However, in the broader picture, we are seeking a silver lining.
Is our market still volatile?
Typically, factors like interest rate fluctuations, corporate earnings, investor sentiment and major economic events can affect market volatility. External shocks can affect investor confidence and contribute to market volatility.
Political, economic or corporate occurrences cause short-term volatility. Often, investors quickly realise such an event is not as significant as originally thought, and the market tends to rebound quickly.
“We don’t anticipate a volatile period in the near future,” said Commerce Trust Bhd chief executive officer Yeoh Keat Seng.
He asserts that two major market influences, namely the Iraq war and a sharp increase in oil prices, are behind us. In the immediate future, lingering concerns include the weak US and Malaysian economies, the spill-over effect of the severe acute respiratory syndrome (SARS) and occasional terrorist attacks.
Investment opportunities in a volatile market
Investing in a volatile market may create opportunities for investors who are good at investing and timing the market, who are experienced and keep their ears close to the ground such as full-time, professional investors.
“We believe the stock market has stabilised and is probably near the bottom. We expect to see a recovery in the second half of this year. In terms of opportunities in investing, contrarians would suggest it is a decent time to invest in the market. Investors should not look for immediate or overnight gains, but if an investor has a three to five-year investment horizon, now is a good time to invest,” Yeoh said.
Reasons for optimism in the equity market include the fact that much of the bad news is behind us, and the market is at one of the lowest levels in price to earnings (P/E) valuation terms in the past decade. Asian financial markets have recovered in recent weeks and there is renewed foreign interest in regional equity markets.
“The economy is likely to show signs of strong recovery in the third and fourth quarters and it will support a stronger local stock market. There is potential for a strong build-up of liquidity in the market, which will augur well for the recovery of the stock market, as confidence returns,” said Yeoh.
On the link between the GDP and stock market growth, Yeoh said as the economy grew, there was more demand for goods and services, leading to growth in companies’ profits.
“As the economy grows, there is more consumption of goods and services, hence more sales for these companies and greater profit sharing. So, you can link the economy and the stock market to higher profitability as the economy recovers. The rise in profitability will lead to stronger share prices which will, in turn, lead to better returns for investors,” he said.
Investing in bonds and equities in a volatile market
There are a few considerations investors should consider before deciding on the asset classes that suit them best, such as their risk-return profile. Regardless of the volatility in the market, an investor who is risk-averse will probably place most of his investments in bonds rather than equities. A risk taker who has an investment plan with a longer timeframe, who is in his 30s or 40s, may have a larger proportion of his investments in equities compared with bonds.
Another consideration is potential returns. Generally, equities yield higher returns than bonds, so an investor who wants high returns may set aside more funds for equity investments. There is a case for growth in equities, as the former has under-performed bonds for almost a decade. Factors that undermine equity performance are unlikely to be repeated.
Risk is another factor. “Volatile markets can be risky periods for investors and there should be a slight preference for bonds rather than equities in a volatile period. Volatile markets can create good investment opportunities for a select class of more sophisticated investors and not the general public,” argues Yeoh.
Volatility can be a friend, rather than a foe. A fund research analyst noted that fund managers added greater value in volatile markets than during flat conditions.
“Global fund managers can hedge their portfolios to cushion return downside using futures and derivatives. However, in Malaysia, a fund manager’s capability to hedge is inhibited by the current constraint in the derivative market. A simple way to proactively cushion your portfolio against natural market swings is ringgit cost averaging, whereby you invest a fixed amount of money in the same portfolio at regular intervals, regardless of market conditions. Investors are assured of not putting all their funds in ‘at the peak’ and suffering an immediate loss,” he said.
Keeping “cool” during turbulent times
Financial markets have always rebounded from market downturns, though this recovery may take some time. The challenge for investors is to develop and follow a sound investment strategy, and with patience, to acquire the financial rewards you want. Experiencing the ups and downs in the market is part of investing.
Fortunately, we can protect ourselves against market fluctuations without sacrificing the returns we need to achieve financial freedom.
Keep a portion of your portfolio in more stable investments such as short-term bond funds. The CI occasionally falls by 5% or more in a matter of days. That doesn’t mean you should ignore equities entirely, as not all stock prices fall in bear markets. Prices of some high dividend paying stocks remain stable or may rise in a bearish market.
Investors should maintain a broad portfolio of stocks, bonds and cash, with the appropriate mix of asset class depending on the stage of Malaysia’s economic cycle. Essentially, if you don’t need the money in your investment portfolio for several years, short-term volatility shouldn’t give you insomnia!
The above views reflect those of Citibank Bhd as at the date of publication. They are intended for general information and/or discussion of the topic. They are not intended to be relied upon in any way by any investors in foreign currencies or other investment products.
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