Stocks are off to a very strong start this year, but it is hard to remember a time that they looked so vulnerable. Investors may be happy with the 10%+ gains in the S&P 500, but the reality is that stocks could nosedive at any moment. In a sign of how grave the risk is, we challenge you to ask yourself—what is a risk that could make stocks plunge 10% in a day? We are willing to bet 90% of you said “the Fed suddenly restarting hikes”. The core of this rally has largely been predicated on the Fed suddenly reversing course, letting investors breathe a sigh of relief that the central bank won’t hike the economy into recession.
FINSUM: The truth is that the Fed could reverse its position at any moment, which would probably cause a big downturn in markets. That said, we don’t think they will do anything so drastic.
One of the hottest trades in the last several months has been to buy a basket of low volatility stocks. The idea is that one can insulate their portfolio from the market’s fluctuations by buying stocks that are less likely to see swings in value. The problem is, the trade has gotten very crowded. Legal & General Investment Management says that “Low volatility might be becoming vulnerable as investors chasing recent performance and buying into gloomy 2018 outlooks flock into it … It is becoming a relatively consensus position, which for us is a warning sign”.
FINSUM: Low volatility stocks held up well in the tumultuous fourth quarter, but the attractiveness of the strategy has made valuations quite high. Such stocks typically lag in upward markets, so there does seem to be some significant risk here.
Climate change risk has slowly but surely crept into the consciousness of even the most mainstream investors. As its prominence has risen, so too has its ability to impact share prices. With that in mind, here are some of the individual shares most vulnerable to such risk. The names are not what you would expect. For instance, Norwegian Cruise Lines and Royal Caribbean Cruises, along with pharma companies Merck and Bristol-Myers-Squibb were identified as the most at risk. “There are many ways to measure how climate change affects your portfolio. One is to see how the physical facilities of the S&P 500’s constituent companies are affected by hurricanes, sea-level rise, and heat stress”, says Barron’s. One head of ESG commented on the list that “you’re exposed” no matter where a company has its headquarters”.
FINSUM: Norwegian is most exposed because it has so many facilities in Miami, where the risk of rising sea levels is very high. Sorting out these risks is a major challenge and it would behoove advisors to seek out the main data providers for such risk, like Four Twenty Seven.
Markets are up since Christmas, but anybody who feels like they are on solid footing is probably a fool. So one of the big questions right now is how to play risky markets? Well, Barron’s has just published a piece outlining what they see as the best funds for such an environment. The picks are based on 15-year performance, including how funds performed during the Financial Crisis. Here are some to look at: AMG Yacktman, Parnassus Core Equity, Invesco Dividend Income, JP Morgan Small Cap Equity, and Neuberger Berman Genesis.
FINSUM: Not a bad idea to look at the funds that have been the best overall risk managers.
The market is in its toughest position in recent memory. Numerous headwinds, none of which are easy to resolve, are stacked against it. Wit that in mind, banks are starting to publish their doom and gloom outlooks for 2019. Nomura has identified a number of “grey swans” (not black) which could topple the market next year. Some of the most interesting risks they identified included a European debt crisis sparked by Italy, oil plunging to $20 per barrel, the end of populism, and an “inflation sonic boom”.
FINSUM: To be honest, we think these are all very unlikely. What is much more likely is a recession accompanied by a trade war.