Volatility Happens

Market volatility has historically ebbed and flowed with the grand cycles of panic and mania.

Yet despite all the crises du jour over the last several years (including the European debt crisis, U.S. Budget Sequestration, Greek Bailout/Grexit, Annexation of Crimea by the Russian Federation, China’s slowdown, et cetera), volatility has been surprisingly quiet.

Some may argue that this data points to U.S. equities being “due” for a correction of spectacular magnitude.

Betting for a crash, however, may not be prudent.  To quote John Meynard Keynes, “markets can remain irrational longer than you can remain solvent.”

Markets need not crash for us to revert to our long-term Sharpe.  Increasing volatility is only one way to decrease our Sharpe ratio.  A prolonged period of depressed returns – like those we’ve seen in the last year – will also get us there just fine.

So whether our outlook is a crash or just lethargic returns: how can we fight the creeping feeling of ennui for staying invested?

We have a few ideas.

First, we believe opportunity often exists at those places outside most investors’ comfort zones. investors should get outside of our comfort zones.  Asset classes that have been kicked aside by the market may present more favorable opportunities for return going forward.

Second, we believe investors should consider alternative means to portfolio construction.  A traditional strategic portfolio is an obvious choice when equity valuations are low and real yields are high: but we believe there is a significant cost to holding such a portfolio going forward.  Embracing strategy diversification may be a prudent play.

Third, investors might consider the role of alternative strategies that have the potential to generate return in both sideways and negative markets.

Finally, investors might consider how they can take advantage of higher yielding asset classes that derive a larger percentage of their total return from yield than from capital appreciation.  In doing so, an investor can hopefully dampen portfolio volatility while simultaneously tilting their returns towards a steadier source.

Corey Hoffstein is the Co-founder & CIO at Newfound Research, a participant in the ETF Strategist Channel.