What does market dispersion and it's rising volatility mean for investors?

With stock market volatility is on the rise, proactive investment strategies are integral to getting ahead of financial disruptions.

Source: Bloomberg

Stock markets are very volatile right now and many investors will have noticed the value of their portfolios dipping significantly since the start of the year. While hedge fund managers will always seek to outperform the major indices - even during a bear market like this one – a coherent investment strategy and a proactive approach to volatility are crucial.

Why stock volatility occurs

Any experienced investor will understand that share prices, commodities, major indices and forex are incredibly sensitive to a whole array of events - be they political, economic, environmental and social. For example,US. stocks fell sharply when the Fed there increased interest rates in May , while the FTSE plunged by 3% when the UK’s Bank of England announced its own base rate hike .

How’s 2022 shaping for market dispersion?

There’s no way to sugar-coat the situation we’re in at the moment. The first half of 2022 has been one of the worst six-month periods in the history of financial markets. After a bumper year in 2021, many of the biggest indexes - such as the S&P 500 and the Nasdaq 100, began to see a downward trend in January and February 2022 - which continued into the spring and summer.

Here’s an overview of performance of 5 major stock indexes so far in 2022, versus the last 5 years (Data from Google – correct as of 07-2022)

NASDAQ

The Nasdaq Composite Index was down by 29.72% in the first 6 months of 2022, but 5-year returns up to July 1st, 2022, were +80.85%.

S&P 500

The S&P 500 Index is down 20.25% in the first six months of 2022, but 5-year returns up to July 1st, 2022, were 57.7%

Dow Jones

The Dow Jones Industrial Average is down 15% in the first six months of 2022, but 5-year returns up to July 1st, 2022, were +45.22%.

FTSE 100

The FTSE 100 has outperformed many other stock indexes, falling by just 4.48% in the first six months of 2022. but 5-year returns up to July 1st, 2022, were negative at -2.48%.

EU50

The EU50 Index was down 9.26% in the first six months of 2022. but 5-year returns up to July 1st, 2022, were +27.75%.

But let’s put that into perspective.

The U.S has witnessed at least 14 recessions since the Great Depression of the 1930s , and 21 advanced economies were in recession 10% of the time between 1960 and 2007. Sooner or later, markets should pick up, but no one quite knows when.

Why have markets done so badly in 2022? Here are some of the key reasons:

The Russian invasion of Ukraine

Markets tumbled in the wake of the Russian Invasion of Ukraine towards the end of February 2022. This unprovoked war has led to the death of thousands of Ukrainians and the displacement of millions more. It also sent shockwaves through the financial markets.

The rising cost of commodities

During a meeting in June 2022, the European Council argued that 'Russia is solely responsible for the global food crisis'. The cost of commodities has risen sharply since the invasion, with energy and food prices increasing far beyond wage growth. Many companies face higher operational costs as a result.

Inflation

Inflation has risen sharply in many countries. In the U.K and the U.S, it at its highest level for over 40 years. Central banks are attempting to curb inflation by increasing interests, but it is unclear whether this will be sufficient to prevent further inflation rises later in the year or further stock market volatility.

So, we’re in in a bear market

This might sound scary even to the most intrepid investors, or those who remember the 2008 crash. But downturns and bear markets are just a fact of life in the stock markets. The good news is that they are usually much shorter than bull markets, which can last for years.

The last bear market wasn’t that long ago

When the pandemic hit in early 2020, there was a sharp fall in stock market prices, and many countries introduced lockdowns. Some sectors, such as hospitality and the travel industry, almost ground to a halt, while others, such as education and finance, went almost exclusively online. But once government stimulus packages were introduced and businesses started getting used to Zoom, market prices started to recover quite quickly. The 2020 bear market was very short as a result - lasting no more than a few weeks in the U.S.

If, at the start of 2020, you were managing a £1 million fund that was invested in the S&P 500, it would have been worth about £1,430,000 by the end of 2021.

This just shows you how unpredictable markets can be. No one really knows what’s in store in the next year or so, although there are fears of a global recession which could cause more stock volatility and downward spirals.

Should you try dispersion trading?

Some hedge fund managers use dispersion trading methods to try and profit from all prices changes (so profiting even when prices go down). But this is incredibly risky and should usually only be reserved for hedge fund managers with highly sophisticated trading strategies. If you have expertise in this type of trading, it's important to choose a prime brokerage platform that enables you to trade securely and execute directly into order books of all major equity exchanges.

Should you diversify your thematic exposure?

Joshua Kaplan, CFS and Global Head of Research at MarketVector Indices GmbH, which monitors the MVIS Indexes (pure-play, investable benchmark indexes), says diversifying your thematic exposure can help you stay invested during a bear market . For example, the BlueStar Global Logistics Index (BLOGR) was down 22.7% from Jan to May 2022, but this outperformed the EQM Online Retail Index by 19% and the ROBO Global Robotics and Automation Index by 5.52%.
Should you focus on sectors instead?

If a sector appears to be bucking the bear market trend, that might indicate there are lots of overvalued stocks and a bubble that’s about to burst. That’s a good time for hedge fund managers to adopt a shorting strategy. But some sectors may seem genuinely 'recession-proof' or outperform the wider market, for example, by contracting much less than the major equity indices during a bear market.

Which sectors could do well during the current bear market?

The below is purely speculative and has not been determined by technical analysis.

1. Tried and trusted: Commodities

Natural resources like oil and metals are a relatively safe hedge against inflation, despite being pretty volatile. The Bloomberg Commodity Index has risen 30% this year, while the Energy Sector ETF has gained 40% in the same period . How many other indexes do you know of which can beat this?

2. The new kid on the block: The pet care industry

Data from the American Pet Products Association (2020) has revealed that, in the past 3 decades, the percentage of US households owning a pet has risen from 56% to 68%. Many Millennials and Gen Z are embracing pet ownership, which means the demand for pet-themed products is also going up.

Another key driver of this growth is the move from cheap, processed canned pet food to organic, nutritious alternatives. The e-commerce share of global pet care retail sales is also expected to grow from a record high of 23% in 2021 to a new record high of 29% by 2025 (which is a growth rate of about 26% in just four years).

3. High-risk but potentially high rewards: Biotech

Biotech stocks can be very remunerative - provided the treatments receive regulatory approval and can be marketed and sold. With so many revolutionary treatments in the pipeline, many scientists believe we are in a golden age of biotech. Read our article on biotech investments to find out more.

Date de publication: 2022-10-25T14:17:49+0100

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