Equity Market Volatility and Long/Short Investing

After a year of unusually low stock market volatility in 2017, 2018 kicked off with far more ups and downs in the market. At the same time, interest rates are rising, albeit from historic low yields. Bronfman Rothschild recently hosted a discussion with Chief Investment Officer Dmitriy Katsnelson and Boston Partners Portfolio Manager Jay Feeney to discuss strategies for managing market volatility. Part of this discussion focused on long/short investing, an investment strategy that includes buying investments that are expected to increase in value over time while also selling short investments that are expected to decrease in value. Following are some of the highlights of that discussion.

Q: The early part of 2018 was characterized by US equity market volatility. What stands out?

Feeney - What strikes me is the contrast with abnormally low volatility last year. The S&P rose over the 12 months of 2017 with a benign economic backdrop. The VIX, a measure of equity market volatility, measured only 8-9% vs a 13% average. Today, if you consider rising interest rates and bubbly stock valuations, no one should be surprised by volatility. Actually, we think true investment risk has probably declined since January as equity valuations are now at more normal levels creating more interesting opportunities.

Katsnelson – On the bond side, we are watching what is happening with the yield curve. After five interest rate hikes since 2015, investors are now earning something on savings. But the shape of the yield curve is a concern. The curve, which reflects yield levels at various maturities, is normally upward sloping with longer maturities offering higher yields. Yet today, we are watching the yield curve flatten. A yield curve inversion, when shorter maturity bond yields are higher than longer maturity bond yields, is often a precursor to recession.

Feeney – It is true that an inverted yield curve portends a recession 9 out of 10 times, but it fails to predict how bad it will be or even when. The press has a way of oversimplifying this.

Q: What else are the headlines missing?

Feeney - Stimulus in the form of tax cuts has led to a rebound in consumer confidence and a long overdue increase in capital spending. Small business confidence is also at record highs. This has a multiplier effect and will take time to fully play out. In our view, there is far too much focus on tariffs and trade and too little emphasis on what is happening in the underlying economy.