The fears that had plagued markets at the start of the year have seemingly subsided with equity indices around the world posted strong gains over the past month. 
According to FE Analytics, for example, the FTSE All Share has rallied 10 per cent since mid-February as the oil price showed signs of stabilising, banks have shown a degree of robustness that investors weren’t expecting given the threat of financial crisis and mining stocks have come back strongly following a very poor 2015.
However, it must be noted that the UK equity market (at the time of writing) is still in negative territory over 2016 as a whole thanks to the painful losses that were inflicted in the first six weeks of the year as a result of China’s slowing growth, a further dip in the oil price and increased geo-political tensions.
Performance of indices in 2016
Source: FE Analytics
Of course, the heightened volatility earlier in the year was just a follow on from what had been a dire second half of 2015 for risk assets.
While many, for instance, believed the initial correction in August had been widely overblown – few advocated that investors should have piled into the market at any point over the past six months as while valuations were lower, uncertainty loomed large.
However, now most industry commentators argue the doomsday scenario for global markets was a tad over the top, is this feel-good factor within markets set to continue and therefore – by extension – can investors feel comfortable taking risks within their portfolio?
Anthony Rayner, co-manager of Miton’s multi-asset fund range, says it is a very difficult question to answer.
He points out that there has been no improvement in the economic backdrop, even noting that the data is “mixed-to-negative” given there is evidence of manufacturing weakness spreading to other parts of the economy, as reflected in the marked deterioration in the global services survey.
On the other hand, Rayner says global policy has become even more accommodative over the last few weeks thanks to an announcement from OPEC members proposing a production freeze and comments from the Mario Draghi, president of the ECB.
“So, policy action, or the promise of action, has been taken to stabilise markets and, so far, it has had a material impact,” Rayner said.
“Commodities have been strong, not just oil but base metals and precious metals too. Financial conditions have also become easier, for example, US high yield spreads have narrowed sharply (albeit to levels which remain much wider than the last few years), much of it due to the higher oil price reducing the pressure on the stressed high yield energy sector.
He added: “Is the feeling of relief premature or has the danger passed? Is this a classic bear market rally or have markets turned the corner? We remain unconvinced either way.”
As such, he and David Jane – who co-run CF Miton Total Return, CF Miton Defensive Multi Asset, CF Miton Cautious Multi Asset and PFS Miton Cautious Monthly Income funds – are going to maintain defensive positioning despite the recent rally.
Their funds have underperformed their respective sectors since the start of this snap rally, but Rayner isn’t fazed.
“We continue to seek better visibility. The European Central Bank will [have met] on 10 Thursday March, where market expectations are running high, and this is followed by all the major central banks meetings in short order,” he said.
“Germany has important regional elections on 13 March, where we’ll get a sense of Merkel’s support in the context of heightened tensions in the eurozone, not least around refugees, and no doubt some read across to the risks of Brexit. Then we’ll have the first quarter earnings season which starts in April.”
“So, plenty to look forward to but we prefer to retain our broadly defensive bias until we get more clarity around economic data and policy action. As ever, the key for us is pragmatism, and if we continue to get positive price action, combined with improved data, we will act.”
Rayner and Jane’s funds have performed well over the longer term, however. FE data shows since they launched the five crown-rated PFS Miton Cautious Monthly Income fund in June 2011, it has comfortably beaten its IA Mixed Investment 20%-60% Shares sector.
Performance of fund versus sector since launch
Source: FE Analytics
There are those who have taken it a step further than Rayner, however.
In an article earlier this week, Hermes’ Eoin Murray warned that the potential for a US recession, a rise in global forced sellers and increased contagion risk could plunge risk assets into a particularly grizzly bear market in the near future.
“In the event of an economic shock, a lot will depend on the fragility of markets – and to what extent they are undermined by forced sellers. But if this perfect storm brews, we could face a savage bear market,” Murray said.
However, there are those who think investors are right to feel more comfortable about the state of the world.
The likes of Rowan Dartington Signature’s Guy Stephens, for example, thinks long-term investors are making a mistake by sitting on the slide lines.
“Returning to almost exactly a month ago, when volatility was elevated, this would have told us that risk had risen when in fact it hadn’t. What had changed was investor’s perception of the risk and that is a very different thing. With the VIX index now back at 17 per cent, has anything really changed that much from a month ago?” Stephens said.
“This flawed thinking is built into the algorithms that drive the high frequency trading and this serves to increase market volatility. Indeed it was F D Roosevelt that said that the only thing we have to fear is fear itself.”
“The VIX Volatility index is often known as the ‘Fear Index’ and when this is applied to a portfolio managed by a computer based on volatility bandings, the investor buys high and sells low which is the wrong answer.”
The graph below charts the performance of the VIX over the past year. As can be seen, it spiked during August’s ‘Black Monday’ sell-off then preceded to fall. The same has happened to a lesser extent in 2016, which is also illustrated on the graph.
Performance of index over 1yr
Source: FE Analytics
Stephens added: “So, for now, volatility has returned to where it was at the end of 2015, but interestingly the equity market has not quite recouped all its losses.”
“This is most likely lingering doubts from would-be investors who are still somewhat in a state of shock having forgotten what equity markets can do and how scary they can become. No doubt they will feel more comfortable when the market has recovered a little more, but in allowing the fear to take over they have missed a very attractive buying opportunity.”
