Get Paid for Volatility

Weekly Market Commentary 9-26-11
Tim Phillips, CEO – Phillips and Company

Investor and consumer sentiment are near all-time lows and the instinctive thing to do is to follow the crowd and run for the exit.

AAII bullish sentiment survey

u michgan consumer confidence sentiment over decade

Behaviorally speaking I call this, “risk as emotion versus risk as fact”. Humans tend to view risk through an emotional lens. When we see things that may be threatening to us we have a fight-or-flight response. This is a good response for staying alive in a hostile world, but usually not a good response when it comes to investing. When things get bad (sentiment and prices are low) we sell and conversely when things are great (sentiment and prices are high) we buy. Therefore you get the paradigm of buying high and selling low with the typical individual investor.

The good news is we can use sentiment as a contrarian indicator. When things get bad (sentiment and prices are low) and the individual investor is so dour, generally it can be a good time to buy. The real question in my mind is, “what is it time to buy?”

Right now global economic issues are driving the major moves in the markets. The prevailing global economic issues are Europe’s capital flow concerns and the United States’ fiscal policy concerns. Both issues are not likely to be resolved anytime soon.

According to the International Monetary Fund, The European Union is the largest economy in the world. It will take a coordinated effort by all the Eurozone members, led by Germany and France, to get the capital flowing in the region. These efforts will also take time to work their way through the Eurozone financial system and the global financial system.

Rank
Country/Region
GDP (millions of US$)
1
European Union
$16,242,256
2
United States
$14,526,550
3
Peoples Republic of China
$5,878,257
4
Japan
$5,458,797
5
Germany
$3,286,451

As for the United States, the political class doesn’t want to solve our fiscal problem overnight even if stable fiscal policy is what’s wanted and needed. Both sides seem to want to kick the can down the road until elections because fiscal (tax and spending) policies are big ballot items.

If there is going to be continued uncertainty in the world’s two largest economies, then volatility should continue as well. My strong belief is investors should be paid for taking risks. Simply buying stocks and holding during volatile times doesn’t mean you’ll get paid. Based on my belief I’d like propose a tweak to that approach. Look at investments that pay you to hold on during volatile times. If companies can "pay the rent" (dividends or interest) to be in your portfolio, then it can be easier to look past the volatility in price and easier to resist your fight-or-flight instinct of buying high and selling low. Below is a table of asset classes which have been “paying the rent:”

Asset Class

Yield

High Yield US Equities

4.48%*

4.58%**

8.28%**

6.75%**

3.66%**

5.26%**

Emerging Market Debt

4.86%**

*average current yield (less than 12 months of data available).
**12-month yield

Once we see some certainty in fiscal policy for our country and capital flows for Europe we can make a tilt toward growth. In the interim, let's get paid for dealing with the volatility.

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Tim Phillips, CEO – Phillips & Company

tphillips@phillipsandco.com

Research provided by:

Adam Gulledge, Associate – Phillips & Company