Risk, Value and Volatility

Last Friday (Feb. 9), the S&P 500 hit a level (2532), which was almost 12% lower than the Jan. 26 high at 2873. This brought one measure of value, the Price to Earnings (P/E) ratio for  12 month forward looking earnings (earnings growth for 2018 is expected to be about 18% taking new US tax reform into account) down close to the 5 year average near 16 times

(see last Saturday's blog for the chart on this).

Our risk models turned green at this point and our orders for investing recently added client cash saw many of their target prices met and we bought equity assets for our clients and ourselves (because we invest in the same assets as our clients).

Volatility created value (risk levels fell with falling stock prices) and we were able to take advantage of it. Buy and hold strategies were basically stuck on the sidelines.

Yesterday, after about an 8% increase in the S&P 500, risk levels rising again and the 12 month forward P/E values rising to over 17 times, we took some of that risk off of the table. Who can argue with an 8% profit over one week?

Point being is that we were hard at work, monitoring our risk metrics because that is how we mange money, by risk. If stock markets go higher, we will continue to take risk off of the table.

If, as we suspect, there will be more volatility as central banks draw liquidity out of the global financial system as they gradually reduce quantitative easing (and institutions are forced to sell assets), there will be more opportunity to find better value as prices settle at more realistic levels.

One of our more attentive clients sent me this market letter mid-week: The Advent of a Cynical Bubble by market strategist James Montier (worth a look for sure), which interestingly invokes the musical chairs metaphor which I often use, but the week of Feb. 5-9 was certainly an excellent example. Needless to say, last week (on much lighter volumes) brought back the overdone "buy the dip" crowd, pushing market prices back to levels that are less-realistic. 

This push and pull of buyers and sellers could keep volatility relevant for some time to come, especially if the reality of lower levels of liquidity brings greater institutional selling into fewer and fewer "buy the dip" types who are running out of juice.

For our clients, we will monitor all the goings on and continue to do the work of buying value opportunities which enable us, over longer periods of time to reduce risk and portfolio volatility.

In the mean-time, the buy and hold crowd will watch their portfolios swing erraticaly in value, while we build it in ours.