Monday, 13 February 2017

Volatile President

James suggested that my last post was:

A little confusing. Are you still a little jet lagged?
What was the premise of the article and what was the conclusion?
The title suggested a rant but the content was unrelated.
I know people's concentration levels are very low these days but do three weeks into a new presidency constitute a long enough period to perform a correlation study?
Not to be too nit-picky, but the election was actually more than three months ago, so any 'Trump Effect' would have been in-play since November 8th.

The timing could turn out to be coincidence of course, but after eight years of mostly 80%+ correlation, the sudden separation certainly warrants a closer look. A change in President, especially when there is also a change of party, is always a significant event, and Donald Trump with no political experience whatsoever, was always going to have more impact than a traditional new President. I'm not sure many 'experts' were predicting that a Trump win would result in the S&P 500 gaining 8.9% since election day, and the FTSE 100 up 6.4% in that time. 

The 'President Chaos' title was chosen from text in the article I linked to, and wasn't meant to imply any sort of a rant. I think the premise of the article was that a President, who in so many ways is causing chaos in almost everything he does, should be the cause of markets reverting to how they have behaved long-term, is somewhat ironic. Organised chaos perhaps. 

While that is all very interesting, more interesting perhaps is that the lower the correlation between sectors, the lower the overall volatility
Quite a decline from the days immediately preceding the election and close to all-time lows.

As the source article summarises, the lower correlation means three main things:
Point #1: Lower correlations mean less price volatility in the S&P 500. That’s just math: the lower the correlation between assets in a portfolio, the lower the overall volatility. That’s one reason why the CBOE VIX Index has been so low (along with realized volatility). We’ll have to wait and see how much the sector correlations stay low when we get a systemic shock, but for now we can expect volatility to remain under pressure.
Point #2: Getting sector and stock bets right just got a whole lot more serious. As correlations drift lower, different sectors will tend to show greater price and performance dispersion. Use Health Care as an example. Say you under-weighted that group at the end of last year. Big mistake: it is up 4.1% year to date, and only overweights in Tech (+5.9% YTD) and/or Consumer Discretionary (+4.8% YTD) would have saved you so far. No other sector has better YTD performance than those three. 
Point #3: The same goes for international equity portfolios. Emerging markets are up 8.2% in dollar terms so far in 2017. EAFE is up 3.9% - more than the S&P 500’s 3.1% price return.
Good luck if you're trying to beat the overall index by picking individual stocks or sectors.

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