In an erratic and unstable economy, investors may be tempted to run for cover, yet the impulse to shut down and panic can make it all the more difficult for them to meet their individual investment goals. There exists a principle that the recent volatility is fundamentally driven by fear and not deep-seated.

Putting volatility in place

Investors must keep this volatility in check. Pullbacks of 5 % to 10 % where most of investors are today occur between once per quarter to once per year. The present market pullback is not in and of itself an essentially fundamental reason to overreact.

The reason behind the sell-off

At the beginning of the year, the market returns were going to be closely connected to economic fundamentals than in 2012 and 2013 with the global economy needing to follow through on the growth expectations already built into market prices.

The U.S. economy has more or less been able to deliver on those expectations but large parts of the world have not, especially the Eurozone has yet to comply with its part. There was also a slowdown experienced by China and some loss of momentum in Japan.

At the same time, the near absence of an upward pressure regarding wages in the developed world and the continued diminishing declines in commodity prices sparked fears that global deflationary pressures have become well-established.

Investors are also focused on other pertinent global issues such as the recent Hong Kong protest, the Ebola outbreak, Iraq, Israel and Palestine, Ukraine and Russia and the conclusion of Fed tapering , the list basically goes on and on.

A market adjustment, in response to the aforementioned developments, is principally not that surprising. But for all the apprehensions infecting the markets, the big picture is not that very different than it was a couple of months ago.

All defences and non of the offences

The U.S. stock market sectors have not been able to react equally in spite of a bounce-back in cyclical stocks during the recent summer due to the improved economic data. They have underperformed defensive sectors in the past few weeks. The difference between cyclical and defensive performance is a measure of fear and scepticism that is corollary related to the 10-year Treasury yield.

Investment implications

Long-term investors have had the luxury of staring beyond the recent market volatility even as they acknowledge that the global economic trends indicates that the investment returns will be lower and more volatile in the coming months and quarters.

In spite of the recent outbursts, most of the U.S. economic indicators persisted to signal that the economy is expanding. A strong labour market along with a decline in gasoline prices should provide a boost to consumer spending and income. The present earnings season appears to set to produce another quarter of record corporate profitability.

Seeking refuge in a defensive stock market sector is a reversible mistake. Although long-term interest rates have declined this year, they should rise in 2015 especially that the Fed shall be commencing its tightening cycle. Greatly improving economic data should benefit cyclical factors such as technology and consumer discretion which are both considered a strong economic fundamentals.

A sharp rise in the dollar has historically affected the emerging markets but many of which have already seen and experience exchange rate depreciation and are in far better shape to withstand these pressures than they were back in the early nineties.

Overtime, they will be benefited from a much faster growth in the U.S. within emerging markets, many favour manufacturing driven economies over commodity-led ones.
No one actually knows how the next fiscal year will turn out, but the best response for long-term investors is already tried and tested. Focus more on fundamentals and hold a balance and well diversified portfolio.

Last Updated: January 6th, 2015