Professional investors wary of pick-up in market volatility

Investor sentiment is getting more fragile, with the latest Covid variant just one of many risks that could throw markets off course. 

Any new year forecast is a guessing game riven with uncertainties - but there’s a strong sense among expert commentators that 2022 is set to be a particularly unpredictable year in economic and, of course, medical terms. That is likely to manifest itself in greater market volatility, and potentially the need for investors to dial back on their exposure to risk.

Indeed, investor confidence has already taken a knock this autumn, says James Thomson, manager of the Rathbone Global Opportunities fund. “Investor sentiment has certainly got more fragile as we’ve hit many economic, monetary policy and political inflection points.

“This has caused abrupt changes in market leadership and amplified stock market moves. Investors keep churning between reflation, stagflation and resilient growth stocks, with alarming inconsistency.”

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The biggest single unknown looking ahead is clearly the continuing emergence of new Covid variants, most recently the Omicron strain. That is compounded by questions around how governments worldwide react to the changing medical situation, and the impact of those reactions on the global economy.

As David Coombs, head of multi-asset investments at Rathbones, observes, predictions are worthless in this context. “We don’t know if there will be lockdowns next year, or what impact that would have on growth,” he says. “We must be cautious, and we must be flexible, in case markets get hit by the global economy potentially going into a shock recession.”

Simmering inflation a key concern

But the big picture is further complicated by simmering inflation, uneven and questionable growth prospects, governments hamstrung by massive debt levels, and high asset valuations.

The multi-asset team at Invesco are also concerned about the fact that despite recent market wobbles, equities are still so expensive at this time. “Markets have delivered stellar returns in 2021, resulting in stretched multiples,” they point out. Invesco predicts that this could result in profit-taking by investors in coming weeks, adding to the potential for volatility.

Inflation and how governments respond to it may be particularly key in the coming months, suggests Tom Becket, chief investment officer at Psigma Investment Management. He is concerned that inflation might require interest rate rises and monetary policy tightening. He, however, adds: “But the last thing that cash-strapped governments can afford is less support and rising borrowing costs on their teetering debt piles.” There’s plenty of scope for a “policy error” around the whole issue, he warns.

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Coombs concurs, predictingthat inflationary fears will peak in spring 2022. “Until then, there will be a lot of volatility,” he forecasts. “The Bank of England is going to be under a lot of pressure to raise interest rates, which we think would be a mistake, but it will probably do it anyway, albeit dependent on the ongoing Covid situation. The market is going to be really worried about central bank policy errors.”

The Invesco team agree that inflation and global policymakers’ responses are key considerations in assessing the potential for volatility, as are corporate earnings growth and the decline in companies’ margins. “We are very aware that margin pressure could create headwinds for stocks and general market confidence,” they add.

Positioning against uncertainty

Market uncertainty clearly highlights the need for caution. Coombs says Rathbones is positioning itself against uncertainty by holding “very high cash balances, almost no exposure to corporate bonds and an equity portfolio full of companies with pricing power and long-term visible growth”.

And if the tables turn the other way, Omicron slips out of the headlines and volatility dissipates, he believes the more value-oriented stocks in the portfolio will help it to benefit in “an environment of continued cyclical recovery”.

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But volatility also throws up opportunity for braver investors.

Becket points out that some volatility is a welcome development, although he also acknowledges the need to maintain a balanced approach, looking for companies across the spectrum of ‘growth’ and ‘value’ that offer the best balance of risk and reward. He is keeping a close eye out for buying opportunities in the UK, Japan and Asia – all markets on “sensible” valuations.

“The shifts in the key macroeconomic factors could easily lead to the occasional ‘earthquake’ across financial markets and vicious swings in sentiment,” he says, but “the opportunity to buy certain investments at cheaper prices is exactly what we would like.”