Standard Chartered Bank shares its view on investment strategies moving forward, in its weekly market outlook the Investment division makes some insightful observation on the current markets. This is not a research material nor was these comments made by its research unit.
Risk assets have rebounded from late January’s sell-off, but volatility remains elevated. Proprietary indicators suggest investor positions in risk assets, especially in Emerging Markets and global High Yield bonds, remain crowded. This raises the risk of a short-term pullback. Nevertheless, fundamentals have brightened in recent weeks – including the prospect of a quick approval of a USD 1.9trn fiscal stimulus by the US Congress in the coming weeks, a stepped-up pace of vaccinations (especially in the US and UK), upward revisions to US earnings estimates for 2021 amid a stronger-than-expected earnings season and restart of equity buybacks by US banks. Since it is difficult to time markets, we believe the prudent approach would be to stay invested, and use any near-term drawdown to average in.
For sure, the recent bout of volatility showed how stretched investor positions make markets vulnerable to any untoward news. In the latest case, the trigger came from a tussle between investors that had built up short positions in select small-cap stocks and investors who bought into those shares. The resulting so-called “short-squeeze” on investors who were short led to losses and margin calls, forcing them to deleverage some of their unrelated profitable positions elsewhere in the market. While we believe most of this deleveraging is likely over, the market remains vulnerable to other risks such as progress of COVID-19 vaccinations, virus mutations and rising inflation expectations and bond yields.
These risk factors are not new. SCB has been talking about the elevated risk of a short-term equity market pullback for three weeks (see ‘Are markets frothy?’, 15 January), and one pullback occurred at the end of January. Understandably, readers’ number one question is ‘Should I sell?’. This is natural, especially given the fear of regret in the face of potential short-term losses. However, the performance over the past three weeks highlights the challenges with this approach.
First, the indicators used to examine the ‘frothiness’ of markets are not precise timing signals. Second, even if markets do temporarily pull back, an investor will need to time both the sale and repurchase of assets extremely well in order to outperform a “buy and hold” strategy. Meanwhile, if an investor took profits on 15 January and missed the 29 January market bottom by two days before re-entering, then, excluding transaction costs, his/her gains would have been around 0.9%.
Therefore, its believed it is prudent for those who are invested in line with their overall risk tolerance to remain invested. When economic and business fundamentals are turning around after a sharp downturn and policies are extremely accommodative, as they were in March 2009 and again in March 2020, risk assets tend to deliver healthy returns over the medium-to-long term, short-term blips notwithstanding.
Also, the recent volatility in a select group of small-cap stocks is a reminder about the risk of excessive concentration. Long-term investors are better served by holding a core diversified allocation and then using a ‘satellite’ allocation for shorter term trading.