What to do now volatility has returned?

The cause of the sell-off is a growing concern that the Federal Reserve might be behind the curve and need to raise interest rates faster than they have indicated. This view has been supported by data from the US which suggests that wages are rising which in turn will generate inflation. 

The markets had already been slow in fully factoring in the impact of the US Federal Reserve’s plans to withdraw quantitative easing and raise interest rates so has had to adjust to reflect both the current plans and the potential for rates to rise even faster.  

This has led to a rapid change in sentiment. Where investors were looking at the positives of Trump’s tax cuts and were reassured by the feds take it slow policy, both are now causing some concern. The tax cuts could end up causing the US economy to overheat if it’s already at full capacity. 

Outlook for markets

Stockmarkets had got ahead of themselves following the announcement of the tax reforms in the US and there is no doubt after 18 months of low volatility, a sell-off was overdue. 

However the economic outlook is still positive. The tax reforms in the US are supportive of corporate profitability, and earnings are still expected to grow in 2018 which supports market valuations. The tax reforms will have some inflationary impact but, outside of the UK, inflation has remained fairly muted. 

Companies are beginning to boost capital expenditure (CAPEX) which should help improve productivity and feed through to further growth. The US economy can grow further through improvements in productivity without the need to increase jobs or to raise wages.   

Globally the outlook remains positive with synchronised global growth continuing to be supported by loose monetary policy from Central banks.  

Three investment ideas to protect your portfolio

JPM Global Macro Opportunities fund - The team believe that global macro trends are the main drivers of returns for asset classes and they look to identify and exploit these with the aim of delivering positive returns in all conditions and a priority on capital preservation. Current themes include Japanese economic recovery, global political divergence and China in transition.  The fund will invest in cash, equities and bonds and will use derivatives extensively to go short (Sell) a sector.  

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Old Mutual Global Equity Absolute Return fund - This is a systematically run fund using in-house quantitative tools. The system is constantly monitored with adjustments and improvements made regularly. The team believes that markets are not fully efficient and that stock prices often diverge from their fundamental value due to investors’ behavioural biases and style drifts. The investment process behind the fund’s strategy seeks to exploit these biases in a dynamic and efficient way, resulting in outperformance driven principally by bottom-up stock selection. This is a stable and repeatable process.  

Blackrock Gold & General - The manager focuses on investing in a risk controlled manner with a preference for mid and smaller companies with high earnings growth. This fund is likely to continue to suffer whilst the industry continues to reform. However, the manager is experienced and well resourced, and through their rigorous analysis they are well positioned to benefit from any uplift in the sector.

Investors need to keep perspective - markets don’t go up in a straight line and falls of 5 per cent to 10 per cent are not as uncommon as the last 18 months may have led some to believe.  Focus on your own goals and not the short term performance of markets, a sell-off of this magnitude was long overdue. Use the opportunity to ensure you have a diversified portfolio which is well positioned to protect against the volatility of markets.

Adrian Lowcock is investment director at Architas.

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