Lead Story: More volatility ahead

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THE year so far has been marred by a fair amount of geopolitical turmoil, from tensions between Ukraine and Russia to the Israeli airstrikes on Gaza and aggression by the Islamic State in Iraq. Yet, most major stock markets have brushed aside such troubles, charting new highs over the last eight months, save for the Nikkei 225 which has declined 3.46% since the beginning of the year. 

It is interesting too that volatility is down to the low levels of 2006/07, just before the 2008 global financial crisis, led by subprime mortgage problems in the US, struck. In fact, the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options, is now trading at 2007 levels.

Nonetheless, the low volatility in the stock markets over the last eight months could end soon, as investors wake up from their complacency and turn more cautious, opines William F Truscott, CEO of global asset management at Ameriprise Financial Inc, who was in town during the week prior to Sept 08, as a speaker at the 2014 Global Islamic Financial Forum.

Ameriprise has US$810 billion of assets under management (AUM).  

“Things [geopolitical risk] will likely get a bit more challenging, going forward. Situations in China/Hong Kong, the Middle East and Ukraine have not fully played out. I would predict that in the next four to five months, people are going to be a little more cautious than they have been up until now,” says Truscott, who has been involved in financial markets for 32 years.

“The market has mostly ignored the slowing growth in Europe, troubles in Ukraine and the Middle East, and potential interest rate rises. I think these concerns are going to get back on the table again. This wilful ignorance of the challenges out there is probably going to evaporate and people are going to pay more attention to some of the greater concerns out there.”

Truscott says this scenario of stock markets thriving in the face of turmoil and sluggish global economic growth, is the result of a low interest rate environment, the record profitability of US corporations thus far, and equities seeming to be the “place to be”.

“I think markets have the potential to become more volatile [in the months ahead] and as you know, particularly in the US market, fall can be a pretty tricky period. September and October do not have a great history, in terms of market performance.”  

He says the only way the concerns that are likely to cause volatility can be offset, if corporate earnings continue to grow, while investors find pockets of cheap or reasonable valuations in certain markets.

That said, Truscott does not think the record profit margins seen in the US market recently are sustainable, because the companies would need to invest for growth, going forward.  

“It’s hard to see margins getting any better. There is only so much more expense management that companies can do. I think over time, they have to invest for growth.”

Nevertheless, Truscott’s investment strategy remains “overweight” on equities, as he believes they will be the investment of choice in the months ahead, in the face of interest rate rises. However, valuations will be pertinent to decision-making.

“There are not a lot of other options and this is where valuation comes into play. We prefer cheap markets relative to history and median price-earnings, such as Japan, South Korea, China and Asian emerging markets. We are ‘neutral’ on developed Europe and US,” Truscott says.

He sees value in the Japanese market, with its potential for good earnings growth. He also opines that the overall story looks positive for most of the developing Asian markets with their pro-growth policies, thus encouraging faster growth overall, than what is seen in many of the developed markets.

Truscott is “underweight” on Latin American equities, as many economies in the region have not been performing well, while the once emerging market darling, Brazil, has slipped into a recession. Its gross domestic product contracted 0.6% in the second quarter, due to soft consumer spending.

Ameriprise Financial is “underweight” on bonds, particularly those of developed markets such as treasuries, gilts and Japanese government and eurozone bonds, but it is “overweight” on corporate papers.  

“In the world of bonds, we are basically saying [that] we prefer credit and we don’t particularly like government bonds. The rise in interest rates will affect treasuries and long bonds issued by governments, and we think that credit, where you get some coupons that are being paid either high yield or investment grade, still shows that there is so much more traction in it. Overall, we’re ‘underweight’ on bonds and we prefer credit,” Truscott points out.  

Having spent most of his financial career in emerging markets, Truscott says interest in Islamic financing is increasing. Although the market is still nascent in the fund world at present — with less than 1% of AUM globally — he believes it will see strong growth in the future, as it has the right ingredients for growth: increasing affluence, growing population and government policies that promote Islamic financing.

“The market is worth about US$2 trillion and 80% of it is in banking. The rest is derived from funds, sukuk and money market funds. We’re here because we believe in the Islamic market, we believe there is growth. It’s going to take a while, but I predict that if we’re sitting here five to seven years from now, the market will be much larger than it is today.”

Threadneedle Investment, which is a part of Ameriprise Financial, recently obtained its capital market services licence in Malaysia and is now able to offer shariah-compliant capabilities to institutional investors.

“If you ask me if Islamic finance is well understood, I would say no. But do I think if there is increasing understanding of Islamic finance? Yes. People are taking it seriously and we are pretty excited about it,” remarks Truscott.  

This story first appeared in The Edge weekly edition of Sept 08-14, 2014.