Large increases in volatility have become a regular feature for European equity investors over ...
Large increases in volatility have become a regular feature for European equity investors over the past four to five years, according to Robert Buckland, analyst at SchroderSalomonSmithBarney (SSSB).
Buckland says around 20% of the DJ Stoxx Index, made up of companies 150 stocks, moved by over 5% a day during March. He adds the latest upturn is comparable to that seen during the last bear market rally in September 2002.
Buckland says the sustained level of asset volatility is now greater than it was around the 1987 equity crash or the 1990-91 Gulf war, adding the war with Iraq cannot bear all the blame for the increase in volatility across asset classes or among individual stocks. He says: 'The rise and fall of the retail investor will have added to this volatility, particularly in continental Europe. Our analysis of mutual fund flows suggests retail investors were sucked into the bull market and European tech stocks in particular.'
As such, he says, these retail investors have now turned net sellers. He believes many insurance companies have behaved in the same way, and such momentum investing adds to market volatility.
Buckland identifies hedge funds as contributors to higher levels of volatility. He says: 'As long-only investors have sat on the sidelines, hedge funds have become increasingly important in setting the marginal price of European equities. In particular their ability to go short is a new factor, which will have reduced market time horizons.'
Indeed, he suspects shortening time horizons among all investors will have had an important impact on volatility. He says with fund managers now under such pressure to deliver quarterly returns, the temptation to become an aggressive trader is considerable.
James Sandison, fund manager at Edinburgh Fund Managers (EFM), says while volatility has been higher recently, it has been throwing up opportunities for investment. He says investors who like a stock based on its fundamentals that has also been driven down because of the volatility of the market have a good opportunity to buy it at a cheap level. However, Sandison believes this high degree of volatility will not continue in the long term as the market will revert to its mean.
He adds: 'At the end of this bear market, I believe a number of investors will become uninterested in the market and as such will stop contributing to the volatility.'
Buckland says it is important to remember that high levels of volatility have become an increasingly common feature of European equity markets since 1997.
Each of the past four false rallies have been associated with a similar increase in short-term volatility, he notes. As such, he believes a rise in volatility is a necessary condition for a market turnaround, although not sufficient on its own.
Going forward, Buckland says: 'Gulf War uncertainties are likely to keep market volatility high. However, the deleveraging of many European companies should start to reduce stock price volatility over the medium term.'
This is particularly true for the technology, media and telecom sectors, where the relief in balance sheet pressure seems to be helping reduce share price volatility, he adds.
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Excessive volatility will come to an end.
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