How Advisors Can Spot Opportunities for Clients in Volatile Markets
By Chris Latham for Financial Advisor IQ
Market gyrations rekindled in 2018 and economic 2019 forecasts are predicting slower growth. In such a climate, financial advisors can’t rely on a rising tide to lift all boats.
Rather than merely repeat the mantra “stay the course” to wary clients, advisors should consider buying opportunities arising out of volatile markets. It is key, say experienced advisors, to pay close attention to developments in multiple sectors, regions and asset classes to determine the root cause of price changes.
Advisors must then be ready to make a case that can justify selective investment purchases, often by pointing to historical precedent. It’s also crucial to anticipate what global trends might trigger future shifts in sentiment.
“A multi-sector approach allows us to have a bigger opportunity set,” says Elaine Stokes, portfolio manager and co-head of the full discretion team at Loomis Sayles. “In times of transition, multi-sector frees us from being forced into one space. For example, if certain emerging markets seem too risky, perhaps we can find late-cycle value in U.S. securitized debt.”
Stokes points to high-yield debt as an area which has recently presented opportunity, based on swings from the second half of 2018 through the first couple months of 2019, possibly due in part to the U.S. Administration’s shifting position on Iranian oil sanctions. Oil prices can be a driver of U.S. high-yield debt prices.
Trade negotiations with China and the potential for additional tariffs, coupled with technological advances, have also opened buying opportunities in the U.S. auto industry, Stokes argues. She also points to regulations and central bank action — recently in relation to Brexit — that have done the same with the European financial sector, by presenting new opportunities for strong financial-sector companies to distinguish themselves.
She says advisors need to dig in on the news to discern whether an issue is temporary or a game changer.
For Dryden Pence, a Newport Beach, Calif., financial advisor who oversees approximately $1.5 billion across his firms Pence Wealth Management and Pence Capital Management, opportunity for clients may arise when market volatility stems from headline-induced panic or algorithmic trading run amok.
Pence sees the shipping giant Fedex and the video streaming service Netflix as examples of firms that fell into those categories last year, since their low share prices did not align with their high overall customer demand.
“When we see a company being sold off unrealistically, first we check that the earnings are good and that dividends are safe, and even then we aim to only buy at a bargain,” he says.
Pence also typically has full discretion over his clients’ accounts, keeping anywhere from 3% to 5% cash in portfolios, so he can act nimbly when opportunities emerge instead of having to contact and persuade each client. In situations where he does have to address such concerns, Pence likens the process to buying an item when it is on sale.
Cushioning the fall to protect clients is another opportunity for advisors.
“Our job as a money manager is to prepare our portfolios for bouts of market volatility before they occur,” said Jaime Desmond, chief operating officer of Ladenburg Thalmann Asset Management, which oversees $2.7 billion for investors and advisors nationwide from New York. “That is just what we did during the selloff in the fourth quarter of 2018.”
From the Sept. 20 peak through the Dec. 24 trough, the S&P 500 lost 19.36% on a total return basis. Desmond’s team held liquid alternative mutual funds which mitigated those losses, dropping only about 7% during that time.
“These funds allow us to be overweight equities during a time when the economy continues to be on solid footing without taking on the same volatility as the market, by use of option strategies,” Desmond says.
Longer term, financial advisors should watch for a sentiment shift in markets, signaling recession, according to Stokes of Loomis Sayles. In her view, although much hinges in the next three to nine months on whether the Trump administration resolves tariff disputes and whether the Federal Reserve keeps easing the pace of interest rate hikes, U.S. economic growth could persist for another couple of years, even if more volatility hits.
Capturing opportunity for clients during that time will require advisors to understand the new information paradigm affecting markets, she warns. Namely that the Fed appears to be openly factoring market moves into its rate decisions and coordinating with other major central banks globally, while some institutional and retail investors alike are making trades based on political tweets — none of which occurred with any regularity before the 2007 financial crisis.
“All this means sentiment can shift very quickly,” Stokes says. “So, we are prepared to sell some assets likely to exhibit continued volatility, and with each bout of volatility we seek to build out a base of long-term investments.”