For the year to 11 May the S&P500 index is down 4.8% and the Nasdaq composite is down almost 16%. Th...
For the year to 11 May the S&P500 index is down 4.8% and the Nasdaq composite is down almost 16%. This is a reversal of fortunes from March when the S&P had risen 4.4% and the Nasdaq by 24.1%. These unprecedented levels of volatility highlight the importance of judicious stock selection over sector or style.
Volatility has been most marked in the technology sector. Volatility among technology stocks has been over 1.5 times greater this year than last. Year to date 77% of the trading days on the Nasdaq have ended with triple digit moves on an intraday basis. The levels of volatility have increased so markedly because of a combination of the level of uncertainty over the US economy and a number of technical factors.
As Alan Greenspan has admitted, the old relationships that existed between growth, inflation and unemployment no longer provide the insight and guidance of the past economic cycles. The US leads the developed world in terms of the percentage of GDP spent on information technology (likely to be over 8% in 2000). The productivity revolution is the secret ingredient which has sustained the cycle to date and on which investors have no prior reference point. In one sense the technology sector is the hedge against rising inflation as companies spend more on technology to offset rising labour costs and increase efficiency. On the other hand their high growth, high valuation nature makes them vulnerable to rising interest rates exerting downward pressure on IT spending.
The rise of the individual investor and day trading has also contributed to these volatile times. Day trading currently represents around 20% of the daily volume in Nasdaq stocks. Day traders are prone to the herding instinct and the impact is exaggerated by the high levels of margin debt relative to total market capitalisation. When collateral falls in price, the necessary unwinding of debt feeds on itself. Brokers arbitrarily sell out of investor's positions to limit losses.
The sharp correction in the Nasdaq and such losses by hedge funds have added to the nervousness of the market.
In March the market was leaning towards the view that new economy stocks could not be valued by old valuation methods such as P/E ratios.
Discrimination by sector is being replaced by discrimination on the basis of individual stocks growth and return characteristics. This refocusing on company fundamentals should broaden the market advance. Near term, volatility will continue, with the market awaiting confirmation of a soft landing, volumes becoming lighter and individual and hedge fund investors trying to recoup losses. This volatility and emphasis on fundamentals will provide exciting opportunities for the discerning stock picker.
Alison Wright is an investment manager at Britannic Asset Management
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