Investors must ‘zoom out’ and prepare for further market volatility

Earlier this month, a weaker-than-expected U.S. jobs growth report stoked fears of a sudden downturn in the world’s largest economy. U.S. stocks slid sharply as a result, with the S&P 500, Dow Jones and Nasdaq indexes recording their biggest one-day declines in roughly two years on Aug. 5.

At the same time, the Bank of Japan’s decision to hike interest rates to levels not seen in 15 years caused an unwinding of the yen “carry trade,” which is when investors borrow in low-interest currencies to invest in higher-yield assets. This led to Japan’s benchmark Nikkei 225 plunging 12% on Aug. 5, its worst one-day drop since 1987.

Meanwhile, the S&P/TSX composite also declined the next day as it caught up to the global stocks rout, which unfolded during a Canadian market holiday.

During the rout, Wall Street’s most-watched gauge of investor anxiety, the Cboe Volatility Index (VIX), registered its largest intraday jump on Aug. 5, reaching 65.

“The events over the last month or so have been an absolute rollercoaster,” Mersch said.

Calm has more or less returned.

The VIX quickly pulled back after its early August jump; it opened at 16.25 on Wednesday. The Bank of Japan has said it will adopt a more cautious approach to hiking interest rates after the recent global market slump. And recent U.S. economic data helped bolster optimism.

Kevin McCreadie, CEO and chief investment officer of AGF Management Ltd., said the worst of the market correction seems to be behind us, given how strongly U.S. equity markets have rebounded, but there may be lingering effects.

“[W]e believe many of the issues that contributed to the selloff still seem unresolved despite equity market moves to the contrary,” McCreadie wrote in an analysis published Wednesday.

Mersch shared a similar sentiment. He cited economic data, interest rate decisions from central banks, geopolitical conflict and the artificial intelligence trade “ballooning and coming back down” as some of the factors that are creating the uncertain macroeconomic environment.

“Expect lots of volatility over the next little while,” Mersch said.

In the face of this volatility, Mersch encouraged reviewing portfolios. 

“It’s really important for a lot of investors over these time periods to really zoom out, check their notes, check their thesis, check the fundamentals of these companies,” he said.

“And one way you could gain comfort in that is rechecking your thesis and seeing, are the fundamental growth trends in your favour?”

Investors should also be cognizant of how much risk they’re willing to take on, Mersch said.

“Say you want to put on nine units of risk — you want to be sort of 90% long within your portfolio. And when there are periods where some of these multiples do look a little bit stretched … you might want to go back to the drawing board to trim some risk in those positions,” he said.

Mersch further advised considering “unloved areas of the market” in times of volatility, such as utilities, real estate and REITs, which were affected by higher interest rates but will probably see growth in the lower rate period ahead, and small-cap stocks.

“Go back into some of these underloved and underappreciated areas of the market. See if you can find value there,” Mersch said.

And when there is mass-scale capitulation and selloff of large-cap stocks, such as the major AI players, Mersch said “maybe it’s time to look back at those fundamentals and look for an entry point.”