Last updated: 10:07 / Wednesday, 30 September 2015
Daniel Chung, 
Alger

Putting Market Volatility Into Perspective

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Putting Market Volatility Into Perspective
  • Volatility is to be expected and, indeed, welcomed by smart investors. Alger maintains that the correction is a buying opportunity
  • "There is no single fact that we can cite to reassure readers that all is economically well globally. Our view is that not much has changed"
  • "On the corporate side of our economy, revenues and profits have been quite resilient despite weakness in foreign markets"
  • The Fed no longer matters. Central bank interest rate management
as a “tool” for managing the U.S. economy and economic growth is fundamentally and largely irrelevant
  • Alger sees a lot of opportunity for growth, profit, and recovery. It beleives the most likely outcome will be a sharp recovery for the markets into year-end and in 2016

With recent equity volatility, news headlines are once again screaming about the collapse of capital markets worldwide and are claiming that conditions globally have not only weakened but have suddenly and drastically deteriorated. "We have many things to say, but will only say a few, with hopes that by focusing on our most important facts, principles, and insights, our message might be heard through the din of the mainstream media", says Daniel Chung, CEO of Fred Alger Management.

This is an extract from the US based asset management firm:

Volatility Creates Buying Opportunities

First, markets are markets, and thus volatility is to be expected and, indeed, welcomed by smart investors. An important fact: U.S. equity corrections of 5%
or more are common — very common. There have been over 200 such declines since 1927.Since that year, the average decline among corrections exceeding 5% has been 12.1% and the median has been 8.3%. The recent correction, with the S&P 500 index declining 12.4%, has therefore been simply average or perhaps just slightly worse. It’s not, however, “unusual,” “extreme,” or “catastrophic” as newspapers and TV commentators suggest. Rather, it’s normal. In particular, we note –he says- that the correction occurred when the S&P 500 and the NASDAQ Composite Index were at post-Great Recession highs. From that perspective, this correction should be viewed as highly normal, rational, and even, may we dare say, pleasing to long-term, fundamental investors. This philosophy of investing is something that Alger has embraced for over 50 years. Simply put, we maintain that the correction is a buying opportunity. We are not alone in this belief, he adds. Warren Buffett, for example, recently said volatility has created even greater discounts on the stocks that he is buying. Investors, he added, should take a long-term perspective rather than focus on volatility. Warren agrees with our view that stocks are likely to be substantially higher in 10 years.

A Look at Economies Across the Globe

Second on our list is the state of global economies, the CEO adds. There is no single fact that we, nor anyone, can cite to reassure readers that all is economically well globally. Yet, our view, based on the research of our investment team and resources provided by our excellent economic and strategic partners across the world, is that not much has changed. Again, the situation is simply not as dramatic as headlines suggest. And, we are at least very certain that nothing has fundamentally happened to imply that the world has gone from “recovering” to “ruination” in such a short time as markets suggest. The U.S. economy is running, or perhaps jogging would be a more apt image. The jogging may not be occurring in every sector or every area, but overall the economy is fine and, unquestionably, better than it was two, three, or five years ago.

For example, consumer confidence is at post-2008 highs and the housing market recovery is continuing, with housing starts reaching 1.2 million units in both June
and July of this year (See Figures 1 and 2). This is steady progress in the housing market, but it remains below, roughly, the 1.5 million unit long-term average that we continue to view as needed to reflect growth in the U.S. population. In comparison, monthly housing starts hit a Great Recession low of only 478,000 units in April of 2009. Shifting lifestyle preferences may be altering the kind of housing preferred by U.S. consumers, but residential as well as commercial real estate continues to be a positive driver for the U.S. economy. Unemployment, meanwhile, has significantly declined and continues to drop. In past commentaries, we expressed our belief that as the labor market improves, there would be variations in unemployment rates among different divisions of workers. That belief was correct. In particular, college educated Americans have had strong employment prospects for several years now and today, with unemployment within this subgroup at only a bit over 2%, they are in short supply from the perspective of employers. Significant improvements have been seen across the less educated subgroups of Americans as well.

Corporate Earnings Have Been Resilient

Similarly, on the corporate side of our economy, revenues and profits have been quite resilient despite weakness in foreign markets. Europe is very mixed, with some countries such as Ireland, Iceland, Germany, and the United Kingdom doing much better than various other countries, including Greece and Russia. But Europe overall is not worse than it was one, two, or three years ago. Looking elsewhere, certain commodity- reliant exporting countries such as Brazil are truly in difficult shape. And –he adds- the Chinese economy is certainly slowing (as it has been for years) as it realigns from being driven by growing exports and by statist policies, including government investment in capital and construction intensive projects, to being driven by consumer services and the private sector. Dislocations in such a massive and shifting economy as China should be expected, but that doesn’t necessarily mean a broader collapse is occurring.

Rethinking the Role of the Federal Reserve

Finally, we provide our strong opinion on a subject that dominates too many headlines and discussions: what will the Federal Reserve do in the near future? Our opinion: the Fed no longer matters. Central bank interest rate management
as a “tool” for managing the U.S. economy and economic growth is fundamentally and largely irrelevant. Many professional investors have expressed concerns over potential Federal Reserve interest rate increases. While interest rates certainly matter, we believe that the Fed long ago lost control of that aspect of the economy and that is a good thing. As we have said before in our Market Commentaries, we are not concerned about the Fed raising rates because the main rates that consumers and corporations borrow at will be determined ultimately by lenders and by debt and bond investors, not the Fed. We think that since the adoption of quantitative easing and the long, unprecedented maintenance of an essentially zero Fed Funds rate, the result has been to show that the once thought “emperor” has no clothes. Do not misunderstand us; market interest rates matter very much. But barring Fed rate mismanagement of an exceptional absolute scale (i.e., the Fed raises rates by 400 basis points, not 50 or 100 basis points), it’s simply that the Fed currently has no real control over rates. We think the U.S. market is indeed reacting to fears of higher rates — but we think the global situation makes it very clear that significant rate increases will not happen in any absolute sense. Rates are declining across the globe, making U.S. nominal rates more attractive (even as they do nothing or, as shown in August, decline slightly) to global investors. Much to the dismay of those who wish the Fed to be truly the emperor of our economy, corporations (driven by the dynamic individuals who work at them) are innovating, competing, growing, and realigning their businesses for the future, regardless of what the Fed does or doesn’t do. We see the real markets offering U.S. companies many advantages in the recent rout: lower commodity and energy prices (costs), increased buying power for international expansion, and increased workplace attractiveness for an increasingly global labor force. U.S. workers — despite persistently flat nominal wages — are also benefiting tremendously from lower costs for many basic necessities as well as from the productivity or “enjoyment” enhancing values delivered by technology and Internet industries. As an example, 20 years ago, many well-off U.S. citizens owned a camera, a video camera, a CD player, a stereo, a video game console, a cellphone, a watch, an alarm clock, a set of encyclopedias, a world atlas, a Thomas Guide, and other assets that had a combined cost of more than $10,000. All of those items are now either standard on smartphones, or they can be purchased at an app store for less than the cost of a cup of coffee.

Drivers of Equity Market Performance

What does matter? Corporate and consumer fundamentals are driven by opportunities, changes, and challenges that are abundant in the real economy, the real world. And we see a lot of opportunity for growth, profit, and recovery. With that in mind, we believe stock markets will oscillate on uncertainty, but we believe the most likely outcome will be a sharp recovery for the markets into year-end and in 2016, the expert says. As an active equity manager with a research-driven, fundamental investment strategy, we think the potential for generating substantial returns by investing in leading companies that are innovating, growing, and taking advantage of incredible opportunities within the U.S. and global economy is highly attractive.

 

 

 

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