Advisers brace for volatility as Syria turmoil looms

Add the unrest in Syria to the list of obstacles facing the financial markets in the weeks and months ahead.

August finished as the worst month for the S&P 500 since May 2012, a clear sign that investors are already bracing for another ugly budget debate in Washington, as well as the rising interest rates that will result from a reduction in the Federal Reserve’s five-year quantitative easing program. The prospect of deepening U.S. involvement in Middle Eastern turmoil won’t help.

“Syria is another external hiccup for the U.S. markets, like the other thousand times we have threatened to do something in the Middle East,” said Sam Jones, president of All Season Financial Advisors Inc.

Fearing the unknown

The financial markets may be reconciled and in some ways immune to the ongoing Middle East problems, but the potential trouble still represents another geopolitical unknown.

“The markets hate uncertainty and [the situation in Syria] is inherently uncertain,” said Alexander Young, a global equity strategist with S&P Capital IQ.

The S&P, which lost 3% in August, saw volatility increase last week on fears of impending U.S. military strikes against Damascus. U.S. officials had said that intelligence indicated that Syria had used chemical weapons against its own people, paving the way for the U.S. and its allies to react.

The initial market sell-off largely can be attributed to volatility in the energy sector, Mr. Young said.

Despite the market’s reaction, advisers said they don’t expect to go to cash or seek safe investment havens at this time. Instead, most advisers are watching and waiting — and holding nervous clients’ hands.

“We’re not running to the sidelines,” said Meg Green, founder of Meg Green & Associates Inc. “Any time there’s been a war, it bodes well for the market. Will there be shakeouts? Of course, but it’s not the time to run away.”

Mike Mills, an adviser at an eponymous firm in Southlake, Texas, agrees.

“When there’s uncertainty and volatility, you’re going to get calls,” he said, noting that two or three clients have called with questions on how to best adjust their portfolios amid Syria’s conflict. “We tell people to stick to their asset allocation and buy into weakness if you’re feeling optimistic.”

Mr. Young reiterated that it is important to keep in mind that even without the mounting turmoil in Syria, the financial markets have been growing increasingly nervous about a list of upcoming tests, including the reduction in quantitative easing and a new budget debate in Washington.

“We were in the midst of a pullback based on Fed tapering in a sluggish recovery,” he said. “There are fundamental concerns that have nothing to do with Syria.”

Jim Russell, a senior equity strategist at U.S. Bank Wealth Management, said he thinks that one of the few certainties at this point is market volatility.

“It’s our take that the Syrian situation is very serious and it has the potential to spill over geographically to other countries, but this is not a one-and-done thing. It is likely to play out over the next several weeks,” he said. “It does have our focus because our clients are concerned, and we’re concerned, and it is happening at the very time when the Fed is looking to start tapering and Washington is looking to debate the budget.”

Throwing a major geopolitical event into the mix, he added, has the potential to derail the Fed’s tapering plans.

“We think the markets are reasonably valued and we don’t think this is a time to get out,” Mr. Russell said. “But the nastier it gets [in Syria], the higher oil prices go, and the higher oil prices go, the more impact that has on the global economy.”

Market valuations aside, most investors are conscious of the fact that the S&P 500 has gained 16% from the start of the year, following a 16% gain in 2012. With that in mind, any kind of buildup to a major geopolitical event is likely to trigger some selling.

“I think when you have a market that has risen to recent highs and folks are already tentative, any news like what is happening in Syria will be a good excuse for taking some profits off the table,” said James Ball, principal at Ball Financial Services.

Steve Blumenthal, chief executive of CMG Capital Management Group, described Syria as a “very significant risk,” but added, “In the developed world, any risk is amplified because of an overpriced market.”

Some advisers expect an overreaction by the market. Robert Isbitts, founder and chief investment strategist of Sungarden Investment Research, said, “The Syria situation is much more distressing from a humanitarian standpoint than from a financial one.”

“Using chemical weapons against your own people is despicable, but I don’t think it will cause any lasting damage to the markets or even to emerging economies,” he said. “But, of course, the market will overreact; it always does. That’s how we got to new highs on the S&P 500 from the sub-700 low in 2009.”

Late August quiet

So far, advisers aren’t hearing much from clients. Indeed, the recent shake-up in the markets is taking place at a time when many are getting in last-minute summer vacations before Labor Day. Further, there have been plenty of scares to keep investors on their toes, including the bond panic earlier last month.

“It’s a combination of when [the downturn is going on] and people being so burnt from all the noise,” said Douglas K. Flynn, an adviser with Flynn Zito Capital Management.

“It’s serious business, because it’s hard to know how folks in places like Russia will react, and that is a greater concern,” he said. “But from an investment perspective, I frankly look at these times as opportunities for long-term investors to buy.”

Message to investotrs: Hold tigh

Advisers said they’ll tell investors to hold tight and to keep sight of their own long-term objectives. “What makes Coca-Cola less valuable if we attack Syria?” Ms. Green asked. “The markets don’t frighten me.”

Though she recommends that clients focus on ensuring their portfolios are balanced and diversified, Ms. Green said that now is hardly the time to go running to bonds, which still are smarting from a jump in interest rates.

Alternatives are another idea, particularly preferred securities and master limited partnerships, albeit in small quantities. “We’re looking for alternative places to go where someone can have a different flavor,” Ms. Green said. “We’re embracing energy by using MLPs.” Though these investments can be volatile, they produce tax-advantaged cash flow, and that can assuage the fears of jittery clients.

Emerging markets also could present a plum opportunity, Mr. Mills said. “If they get cheaper because of war, then that’s a good buying opportunity.”

Advisers haven’t yet reached out to clients about Syria, and given all of the headlines right now that might be a good thing.

“If you think of retail investors, they’ve been pretty cautious all year, and they don’t need any new reasons to worry,” said Paul Christopher, chief international strategist at Wells Fargo Advisors. In a research note on Syria, he remained positive on the U.S. economy and the stock market.

“The tough part is keeping people in the market and making sure they don’t feel like their savings are about to be swept up in a series of crises,” Mr. Christopher added.

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