As Russian novelist Fyodor Dostoevsky once said, "Man is sometimes extraordinarily, passionately, in love with suffering." This notion resonates in the world of investing, where short-term challenges often lead investors to act on impulse. Instead of enduring the temporary storms, many choose to cash out prematurely, transforming temporary discomfort into lasting regret, when they could have stayed the course and benefitted in the long run.
This analogy has become increasingly relevant recently with most major equity indices facing significant fluctuations. Several factors have contributed to this volatility. Firstly, the Bank of Japan's decision to raise interest rates to 0.25%, coupled with a stronger yen and weaker-than-anticipated earnings forecasts from major tech companies, triggered the unwinding of the yen carry trade. Secondly, geopolitical tensions and disappointing U.S. employment data indicating a slowdown in the economy intensified market drawdowns, creating conditions not seen in some time. The chart below illustrates the surge in volatility driven by these intraday swings. The rapid shift from low to high volatility has prompted major investors using leverage and momentum strategies to receive a figurative 'tap on the shoulder' from their risk management teams, necessitating a revaluation of their positions.
Equity volatility
Source: Morningstar Direct, VIX used to measure equity volatility.
On Monday, August 5, 2024, the TOPIX index of Japanese equities plummeted by 12.23%, only to rebound by 10.53% over the following two days. As illustrated in the chart below, a £100 investment made on August 2, 2024, would have dropped to £87.80 on August 5, 2024, following the largest Japanese equity drawdown since 1987. However, had you held onto your investment, on August 9, 2024, your portfolio value would have been £97.90, reducing your loss to 2.14% instead of over 12%.
TOPIX
Source: Morningstar Direct as at 09/08/2024
Market drawdowns, like the one we just experienced, are a normal course of history and have occurred many times in the past. For instance, the S&P 500 experienced a sharp 9.5% drop in a day on March 12, 2020, and a 4.3% one day drop on September 13, 2022. While these one-day drawdowns can be alarming, the equity indices have consistently shown resilience, often bouncing back and continuing their upward trajectory over time. These short-term drawdowns are regular part of the economic cycle, reinforcing the importance of staying the course over the long term in line with AJ Bell’s belief.
1 year rolling return of S&P 500
Source: Morningstar Direct, as at 09/08/2024
Our investment approach is designed for the long term. Since time is the greatest ally an investor can have on their side, we utilise this mantra whenever managing our portfolios so that short-term periods of panic or euphoria do not blow us off course from our investment objectives. By filtering the news from the noise, we avoid the mistakes that befall many investors in the market.
Where the Investment Team sees an opportunity to enhance the risk-adjusted return on a long-term basis, either by increasing the return or reducing the risk, a tactical adjustment may be made to the annual strategic asset allocation (SAA). At the start of 2024, we were nervous that there could be some bumps in the road during the year and as a result, we added some duration via government and corporate bonds, reduced high yield bonds and added some unhedged US Dollars. This didn’t really help much during the first half of the year but with heightened political risk, weaker economic data and central bank adjustments, this positioning may well start to add value through the rest of 2024.