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Total recall

Retour de la volatilité

The beginning of February reminded investors that volatility was not a thing of the past.


Before returning to the episode of the beginning of the past month, the sudden drop in the equity markets was a reminder of two fundamental principles:

The first is a reminder: Volatility does not follow a linear trajectory, it can bounce back abruptly and unexpectedly. At the same time, gains made for several months or even years can evaporate in a few days if not a few hours. For all those who are only long investors, and this is the majority, it's a reminder. When building a portfolio, the correlations between the assets that constitute it, and the evolution of these, are essential for its robustness. Portfolio construction is key. The risk budget of a balanced portfolio is mainly composed of the risk coming from the equity allocation. The volatility of the stock market is traditionally between 15 and 18%, 2017 was a standout on this point. Talking about correlation, in February, and for the first time in many years, long-term treasury bills have no longer offered any protection, since the rates hardly moved during the correction.

The second principle is that economic fundamentals need not be degraded, for the market to undergo a correction or even a "bear market". Growth is currently good, in all regions, consumption is buoyant, credit is expanding, industrial production is returning, and confidence is surging. At the same time, central banks, with the exception of the FED, are still deploying unconventional strategies, which 9 years after the great financial crisis, would suggest that they are normal. The balance sheets of the world's five largest central banks have risen nearly 20% over the past year (BCA chart).  Central banks are dovish. Liquidity is plentiful. Finally, corporate profits should grow between 10 and 17% in 2018. The economic and financial landscape is just fine.


The bull market that we know since 2009 is now old, and we are very probably closer to the end of it than its beginning. The global debt stock has risen another 50% since 2008, valuations are historically high, even if they are not yet at record levels, credit spreads are low, and rates are still at unrelated levels relative to fundamentals.

It is therefore important for any manager and institution that manages portfolios on behalf of others to have a very disciplined and factual management process. No one can predict the markets, nor the intensity of the rises or falls. The role of investment professionals is to manage at best their risk budget in order to be able to tame any rise in volatility. To do this, one must be able to have a disciplined investment process and a set of indicators and to manage as well as possible the correlations and the evolution of these. This is the only way to be consistent over long periods and to achieve results in line with customer expectations. With few exceptions on the planet, no one is able to deliver positive performances regardless of market developments, what is often called "absolute return". This is an intellectual scam that usually allows the manager to take commissions and the customer to lose his illusions. For those who still doubt it, the timing is usually luck, yes luck. So, do not count on it.


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