On February 24th, Presidents, PhDs, CEOs, CIOs, and Executives from industry power-houses like BlackRock, JP Morgan, Cambridge, Vanguard, and Merrill Lynch packed into the Belo Mansion in Dallas, TX for the Annual Private Wealth Texas Forum hosted by the Markets Group. Reuters reported that over 250 leading family offices, RIAs, and Private Bank executives would gather for this closed door discussion on investment strategy, wealth protection trends, and other challenges facing the industry.
Including on the short list of industry experts asked to speak at the event was WorthPointe CIO, Joshua Wilson. The following is based on notes taken at the event, which includes questions that were asked and highlights from Joshua’s responses to a few questions, which are often tackled by multiple experts.
What’s causing volatility in financial markets?
Joshua: I guess the easy answer to that is fear: China, Oil, Interest Rates, Elections, etc. Fear seems to be the culprit because at times we’ve been completely divorced from fundamentals. The discussion we need to be having is how this volatility fits into a historical perspective. We tend to have a recency bias when it comes to volatility. We’ve been lulled to sleep with pretty low sustained volatility for a few years now. Even the spikes in the second half of 2015 weren’t as severe as what we saw in the few year prior. Think of it this way, here in Texas, if we have 100 degree weather for 6 months in a row, then it suddenly it drops down into the 70s, you will see people in coats and sweaters because it’s “so cold.” Well it’s not really cold at all, but it sure seems cold because of the recency bias we’ve developed as a result of the recent hot weather.
Another thing to be careful of is thinking of volatility in terms of absolute price fluctuations instead of in percentage terms. Someone told me that in his 40 years of investing experience, he doesn’t remember the S&P 500 fluctuating by 50 points in a day so frequently. Well 20 years ago, the S&P 500 was at approximately 465. 50 points would’ve been a huge deal. Now that it’s (the S&P 500) flirting with 2000, 50 points is a bigger than average 1 day move, but it’s not that big of a deal when you put it into percentage terms and in a historical perspective.
What do you see in China? What implications might this have for the U.S.?
Joshua: First let’s take a step back and review the conversations we’ve been having about China for the last few years because we tend to forget so quickly! We’ve been asking “why would a country, who is poised to overtake the U.S. and dominate the world, keep buying our debt when they are already growing so fast and strong? Meanwhile the U.S. is struggling to come out of a recession and still creating money hand over fist.” Well the fact is that China is still an emerging economy, but China has been pumping steroids into their economy. The thing about steroids is that they become less effective the more they are pumped into the system. So, a backtrack, or detox if you will, is healthy. Also, we should look to the U.S. and take it as a sign of health that our market has been able to weather the storm so well considering traditionally, the U.S. markets have followed Chinese markets. Sure, we’ve pulled back but pull-backs are healthy and we’ve not gotten absolutely buried like the Chinese markets have. While we complain about low rates, if we compare ours to China and Europe’s, we not only look like an extremely safe haven, we are–comparatively speaking–very strong. We also have a comparatively attractive interest rate for government debt investors. Those facts of course make a statement on asset allocation.
Group Discussion: Oil
Joshua: The U.S. has become a much better and more efficient oil producer. The high oil prices of the past combined with domestic pressure for energy independence actually made it profitable for us to invest in our processes and thus be able to keep drilling profitably as oil fell to levels that would’ve never been profitable before. The U.S. becoming a competitively priced oil producer and having more oil production has shifted more supply on the market. This has prepared the U.S. to become a more significant exporter of oil.
The Saudis have been able to play the role of swing producer but with so much oil coming onto the global market, it seems to me that a game of chicken has developed–even between the OPEC countries. The Saudis, I understand, have committed to pulling back production but only to levels from the beginning of the year–that’s not a big deal. The problem is that everyone knows supply needs to be tightened but if you are the first to tighten supply, you risk a permanent loss of market share when even a temporary loss could badly damage many of these countries who are oil dependent. Even domestically, the rigs that are being shut down aren’t the ones that were supplying much anyway, as far as I can tell. That being said, I can’t see a strong case for supply tightening in any meaningful way with the information we have right now.
We’ve discussed a lot of challenges today, but Joshua, what do you expect to be the greatest of those facing investors today in terms of asset allocation, and what should investors do?
If you’ve got a long-term plan already in place that you understand and believe in, now is not the time to panic and abandon it because it’s times like now, when it feels uncomfortable, when it’s actually the most valuable in the long run. To answer your question on the greatest risk facing investors, I’d say the greatest risk is increasing correlations between asset classes. The IMF came out with a study in April of last year discussing how in the last five years correlations have risen, especially during times of turmoil. Of course, we are used to seeing correlations rise during rough times but the degree to which it is happening, and even during a really good time in the market, is out of the ordinary. Keep in mind that this is post 2008–during a good time. I think specifically they mentioned correlations between high yield and the S&P, and also that correlations between commodities and the market had increased four-fold. Therefore, the problem is that traditional asset allocation relies on variance in correlation between asset classes.
As far as how to deal with that? If one doesn’t already have a long-term plan in place, he or she might look more to non-traditional asset classes. They aren’t appropriate for everyone but there is irony in all of this worry about volatility, because that very volatility can almost be considered as an asset class in and of itself. For example, extra volatility can actually be a good thing for certain options strategies. More volatility actually opens up the possibility to do strategies that just don’t make sense in low volatility environments or that don’t give us many chances to trade when volatility is low. Strategies using options that are more market neutral may also make sense for some investors–in other words, strategies that aren’t dependent on the market to go up in order to do their job.
Now if we take a step back and look at the globe, we look quite attractive. As much as the FED wants to raise rates, they’ve also got to deal with the fact that they don’t really have to at this point. On another front, being that even at these low rates, we are still able to attract capital from abroad. Money is still flooding into the U.S. from places needing a safe haven from terrible economies or negative interest rates.
Joshua Wilson, Chartered Market Technician™ and CIO of WorthPointe Fort Worth, TX, has spent his career specializing in using derivatives and technical analysis in his collaboration with with individuals and institutions who seek superior performance while maintaining a strict risk management protocol. His conclusions and impressions of today’s financial markets provides a reassuring perspective on U.S. economic outlook and place in the global market. And if it is fear that we are feeling, then perhaps the best first step is to check bias against historical performance, followed by checking our confidence in our long-term investment plan to help guide our decisions. Either way, there are strategies at our disposal to expose worthwhile financial opportunities.
WorthPointe is a fee-only financial planning firm with CERTIFIED FINANCIAL PLANNERS™ who are credentialed, experienced and owners. We provide financial planning, investment consulting, tax planning, asset protection, estate planning and charitable giving support. Call 800-620-4232 to schedule a complimentary consultation session with one of these advisors.
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