Love It or Hate It, Volatility Is Back: How Pros Contend With It

(Bloomberg) -- In a year full of debate on whether stocks have peaked, one thing’s clear: volatility is back.

Tuesday’s trading showed that in spades, with Japan’s Nikkei 225 Stock Average sliding 3.5 percent at one point before paring to close 2.1 percent lower. China’s Shanghai Composite Index quickly erased its 1.3 percent slump and soared 0.9 percent as trade talks with the U.S. were said to have resumed. And the Hang Seng Index climbed 0.6 percent after slumping more than 2 percent. U.S. index futures also reversed earlier declines.

While Tuesday’s action was triggered by a sell-off in Apple Inc. suppliers, even tech-lite gauges in Australia and New Zealand slipped at least 1 percent. It’s all part of a broader pattern that’s seen more frequent moves of 1 percent to 3 percent in either direction. A gauge of 30-day turbulence in the Nasdaq 100 Index has tripled in five weeks, taking it to the highest since 2011.

Both sell-side and buy-side strategists are adjusting to turbulence in global stocks that may be here to say. The Cboe Volatility Index, known as the VIX, is heading for its biggest annual surge since 2007.

Stephen Innes has a mantra: Never nix the VIX. “One should never disregard it,” he says. “It is the leading fear gauge. It scares the hell out of investors when it moves.” The head of trading for Asia Pacific at Oanda Corp. in Singapore says volatility is “excellent” as long as hedges are available.

Love It or Hate It, Volatility Is Back: How Pros Contend With It

Here’s some thoughts from market players on how they’re incorporating the resurgence of volatility into their strategies:

Communication Is Key

With the new reality having the potential to spook individual investors, advisers have all the greater need to stay in touch with their customers.

“We are looking at new ways to communicate more with clients -- like podcasts, newsletters to resonate the message as cleanly as we can,” said Chris Weston, head of research at Pepperstone Group Ltd. in Melbourne. “As volatility increases, the media reports more, which creates emotions in traders.”

Consider Cash, Options

Volatility is good for brokerages and flow-based businesses but is probably bad news for long-only investors and funds, said Margaret Yang, a market analyst at CMC Markets Singapore.

She has a solution for them: selling out-of-the-money put options in an attempt to pick up shares at lower prices, with option premiums an additional bonus. Or, there’s sitting on the fence. “I tend to adopt a ‘wait and see’ position with some spare cash in hand until things are clearer for trades and dust settles down for the tech sector,” Yang said.

More Coming

The chief investment officer for Allianz Global Investors, Raymond Chan, expects volatility to jump next year as central-bank policies normalize and the cost of capital rises. That makes it all the more important to focus on companies’ prospects, rather than valuations.

“When volatility becomes more extreme, definitely it’s difficult to get the re-rating to come through, so next year you should be focusing on the earnings growth and dividend, rather than PE,” Chan said. Bright prospects can be found in Asia, he added. He anticipates a December rally for the region’s stocks, and a stellar 2019.

Buy During Distress

Fluctuations mean more buy-the-dip opportunities, for those who can take the roller-coaster ride.

“Volatility opens up a buying window for funds with a six-month to more-than-one-year investment horizon,” said Cristina Ulang, head of research at First Metro Investment Corp. in Manila. “So the strategy is to accumulate during times of market distress -- but very selectively and slowly, with an eye for quality stocks.”

Ross Cameron, head of Northcape Capital Ltd.’s Japan office, agrees.

“With the return of volatility to equity markets, we have probably seen more opportunities to buy excellent companies at discount valuations this year than in any in recent memory,” he said.

Pay Attention

For anyone other than super long-term investors, greater fluctuations at the most basic level mean having to keep a closer eye on developments.

“If everything was euphoric and expensive like it was in 2006-07, it would be easy,” said Nader Naeimi, head of dynamic markets at AMP Capital Investors Ltd. in Sydney. “But there are huge divergences presenting opportunities. We need to have a symmetric view of downside risk versus upside potential. Hence the need to be agile and dynamic.”

©2018 Bloomberg L.P.