The year is only six weeks old but financial advisers and market analysts already are bracing themselves for an investment environment in which the relative calm of 2013 is fading quickly in the rear view mirror.
And Friday's weaker-than-expected unemployment report did little to quell their concern.
“We're getting some data points that are a bit surprising to the growth scenario that we had in mind for 2014,” said Jim Russell, senior equity strategist at U.S. Bank Wealth Management. “We thought the equity markets were due for a nice pullback as we finished 2013, although the catalyst was not evident to us.”
Advisers scrambling to reassure nervous clients over the recent spike in market volatility found little comfort in Friday's much-anticipated jobs report. The unemployment rate hit a five-year low of 6.6% but job creation slowed, with only 113,000 jobs added in January, thanks to slowdowns in sectors such as retail and education. Economists were expecting about 180,000 new jobs. Adding to investor concerns, the unexpectedly weak job numbers from December — just 74,000 new jobs created — were not revised significantly upward as some had hoped.
The mixed report compounded concerns from earlier in the week when the Federal Reserve's tapering sparked a selloff in global equity markets, most distinctly in the emerging markets. That decline spilled over into U.S. stocks, which were coming off a 7% drop in January.
It appeared that investors were voting with their pocketbooks. For the seven-day period ended Feb. 5, U.S. equity funds shed $24 billion while stock funds worldwide suffered $28.3 billion in outflows, according to a report released Friday by Citigroup Inc. Fixed income picked up some of the slack as investors moved $13 billion into U.S. bond funds last week, the report said.
“This week's volatility is certainly more normal than the brutally low volatility investors 'enjoyed' much of last year, though it is higher than even a normalized volatility environment would call for,” said David Bahnsen, an adviser and senior portfolio manager at Morgan Stanley. “My own take is that we will continue to experience higher-than-normal volatility for a while as macroeconomic news dictates market sentiment and investors have a bias towards hitting the sell button at the sniff of bad news.”
As global markets began to disengage in early January, volatility in U.S. stocks spiked with triple-digit point swings by the Dow Jones Industrial Average becoming regular occurrences.
But despite the Dow's drop in January, the volatility level was still below historic averages. It just felt high. At the end of January, the volatility index, also known as the fear index, reached 18.4, from 11.8 earlier in the month. The market's average volatility going back to 1994 is 20.8, and that includes such extreme periods as late 2008 and early 2009, when the VIX was at 90, and 2006 when the VIX fell to around 10.
“Volatility for the most part is actually good for investors because it allows you to pick your spots,” said Diane Jaffee, a portfolio manager at The TCW Group Inc. “The volatility felt a little unnerving in January because it started creeping up.”
That left many in the financial advice community playing defense, with a lot of advisers fielding calls from nervous clients while simultaneously embracing more-conservative investment strategies.
“I'm telling my clients, first of all, we saw the potential for this kind of market pullback and that's why they already have a hedge in [their] portfolio. I'm also telling them if we get to a fork in the road, we're taking the more conservative path,” said Robert Isbitts, founder and chief investment strategist at Sungarden Investment Research.
Now that the Federal Reserve has started cutting back on it monthly bond purchases, investors are seeing the potential for higher yields in bonds, which are drawing a lot of hot money out of the emerging markets in a hurry. Some $14.8 billion flowed into debt worldwide in just the seven-day period ended Feb. 5, according to the Citigroup report.
“Speculative investors saw the writing on the wall with the tapering announcements, because now Treasury rates are going to rise and that will hurt the emerging and frontier markets,” said Doug Coté, chief investment strategist at ING U.S. Investment Management. “It's all that QE money coming back home now that quantitative easing is ending.”
As Mr. Coté explained, the global economy feels the pain of the emerging markets directly and speedily.
“The emerging and frontier markets now contribute 38% to global GDP, which compares to 20% a decade ago,” he said. “That means a decade ago, a little unrest in the emerging markets would have hit our economy months later, but now it's direct.”
Investors are clearly nervous, which compounds the impact of every bit of fresh economic data, reminding them of the interconnected nature of the global markets.
Defense has been the name of the game for more than a year for Theodore Feight, owner of Creative Financial Design.
“I've had a few calls from clients who want to know if we're prepared for this market volatility, and I remind them that I've been telling them for a while that this was coming,” he said. “We've had [sell] stops kicking off on individual stocks like popcorn lately.”
While the news was unsettling for some, many strategists attribute the volatility to a temporary bump and are maintaining their positive outlook for the year. The initial equities sell off earlier in the week may have been a “knee-jerk” reaction on the part of investors who wanted to lock some 2013 gains, said Mike Ryan, chief investment strategist at UBS Wealth Management Americas.
“The economic data has not been uniformly strong but we really haven't seen this confirmation that the strength we saw in the second half was illusory,” he said. “We're staying the course right now in terms of market position because we think this is transitory and not changing the view on the market or the outlook.”
Advisers echoed the sentiment.
Scott Miller Jr., managing partner and chief executive of Blue Bell Private Wealth Management, said his clients are not “overly anxious yet,” because they are still basking in the strength of last year's performance.
He recognizes that the winding down of quantitative easing is the painful consequence of the economy's strengthening to the point that some believe it is now strong enough to stand on its own.
“I think the volatility will be creeping its way back into the market, and with tapering under way, the market will have to start relying more on fundamentals,” he said. “But I still think we'll see a positive market by the end of the year.”
Mr. Miller has had clients asking about taking advantage of market pullbacks, particularly in some of the harder-hit emerging markets.
“I wouldn't go whole hog in the emerging markets, but it might be a good time to dollar-cost average your way in,” he said. “I think it's a great thing to go into with ETFs, and it's probably not too early for a long-term investor.”
Mr. Feight was not expecting a very strong start to the year, but he is looking for a market low point within the next few months, at which point he will put some cash to work.
“With the extra cost of Obamacare, we knew the companies were going to have to take some money out of the economy, and now the cold weather has also taken some money out of the economy,” he said. “The cold weather has been great for the price of natural gas, but nobody is buying anything else that they can't buy online.”