investment viewpoints

How to stay diversified when volatility rises

How to stay diversified when volatility rises
Aurèle Storno - Chief Investment Officer, Multi Asset

Aurèle Storno

Chief Investment Officer, Multi Asset
Florian Ielpo - Head of Macro, Multi Asset

Florian Ielpo

Head of Macro, Multi Asset

In the first three weeks of 2022, global markets witnessed intense price action that is more usually seen over an entire quarter. While last year hinted at a more turbulent environment in 2022, the intensity of the change in sentiment this year proved both pronounced and somewhat surprising. 

What drove such seismic shifts and what potential outcomes do we foresee?

Need to know

  • Signals of greater dispersion and a rotation to value stocks in December 2021 presaged a fast-paced, bearish rotation that gripped markets in the early weeks of January 2022. 
  • Rising real rates were key to the bearish rotation as inflation indicators rose and US Federal Reserve communication turned increasingly hawkish. 
  • We expect 2022 to see a continuation of the rise in real rates and, therefore, a continuation in the rotation, but at a more sustainable pace.
  • We favour staying long, sharp and diversified: risks are still looming, and dispersion is likely to harshly affect 2022.


December: dispersion and the dawn of value

In December 2021, the attentive investor would have spotted two key elements. First, the dispersion within and between equity indices reached a very high level. Among the many indicators of dispersion, the percentage of NYSE stocks closing above their 200-day moving average fell from 80% in July to 40% in the first few days of December last year1. This suggested a much smaller proportion of stocks were driving gains in the index, signalling a significant turn in conviction.

Our analysis suggests that this does not necessarily compromise potential returns, but rather pairs them with greater volatility: periods of dispersion across stocks usually translate into a period of positive returns but with high volatility. The risk-oriented investor will see in this a period of Sharpe ratio moderation: positive returns but with heightened risks.

The second key element was value stocks starting to deliver solid returns – to the extent that they outperformed growth stocks – for only the second time in 2021. Over a period of one month, growth stocks rose by a solid 2% while value delivered 7% returns2.

Both elements - dispersion and the rotation to value - presaged what gripped markets in January: a fast-paced bearish rotation.


January: bearish rotation on hawkish signals

Indeed, during the first 20 days of the year value stocks posted 0% returns while growth stocks plunged by no less than 8%3.

The divergence between growth and value stocks is deeply rooted in the pandemic and its aftermath. Growth stocks soared by an astonishing 120% from the lows of March 2020 to 2021 due to a delicate combination of fantastic earnings growth and a simultaneous plunge in rates. The world became accustomed to ultra-low rates and – more importantly – to negative rates. In the US, 10-year real rates dipped to -1% while their German equivalent saw levels less than -2%. In that context, growth stocks took it all and Cathie Wood outmatched Warren Buffet by far4

With the Federal Reserve acknowledging the necessity to curb the strength of demand in mid-December, and the firm January inflation report, real rates gained suddenly, rising by about 50 bps. More than any other factor, this rise in real rates fuelled a different kind of rotation, a bearish rotation, on the back of renewed uncertainty.

MSCI value vs MSCI growth vs US 10-year real rates, 2018-2022Multi-Asset-simply-put-Inflation nowcaster-01.svg

Source: Bloomberg, LOIM. As of 19 January 2022.


Unfunded growth washout

World equities declined by only 3% but beneath the surface significantly more agitation was apparent as growth stocks underperformed. The Nasdaq broke a -10% return while Cathie Wood’s famous ARK ETF doubled that loss5. Over the same period, the Eurostoxx rose a couple of basis points and emerging-market equities gained about 1%.

The “unfunded growth6” enabled by the era of ultra-low rates was largely washed out in three weeks, with drawdowns as large as -20% for stocks such as Zoom or Robin Hood7 – representative of a certain new-world economy irrationally buoyed by low rates.


Will January set the tone for 2022?

The essential questions now are: will 2022 continue the trajectory of its first three weeks? How can a diversified portfolio be positioned in such an environment?

The main impetus for the rotation is the rise in real rates. And the chief factor that explains its bearish characteristic is the pace of the rise in real rates, as investors digested a more hawkish stance from central banks and took profits accumulated in the past 12 months.

We expect 2022 to see a continuation of the rise in real rates and, therefore, a continuation in the rotation, but at a more sustainable pace: a normalisation rather than another dislocation.


Why the rise in real rates?

Real rates rise for two reasons: first, because central banks become hawkish. This was the case in 2005, 2013 or 2016 and should be no different at present, especially since central banks have become a major buyer of bonds. Let’s not forget that the Fed now holds assets worth about 40% of US GDP, with a vast majority of US Treasury bonds. The European Central Bank holds roughly the equivalent.

The second reason is a decline in savings: the world has accumulated an excess of cash on deposits. This excess is currently being drained by inflation: consumers most exposed to it now need to tap into their savings to maintain their standard of living. This as well seems more a normalisation than a dislocation at this stage, in our view.


Staying diversified while anticipating volatility

With the continuation of the rise in real rates we expect:

  • A continuation in the rotation within equity indices and between sectors. European and emerging stocks should outperform US ones, where growth is most concentrated. Financials and energy sectors should outperform the technology sector for the same reason. That price action should remain overall bullish – accounting for a slower rise in real yields on the back of solid earnings growth. We choose to stay exposed to equities but in a diversified way, with a preference for well-funded and quality growth.

  • Investors should prepare themselves to navigate more turbulent waters. This can be done in several ways using tailored, derivative-based solutions. For instance, long volatility strategies could offer interesting defensive characteristics, both in equities and bonds, as the volatility of bonds rises. Intraday trend strategies are also a natural way to buffer a portfolio against a sudden rise in volatility. They have proved useful in past dire times – February 2020 being the epitome of an unexpected surge in volatility.

Real rates are now showing signs they could increase as the macro situation requires. Earnings growth should help compensate the negative impact, but the rise in real rates could add to the currently more volatile environment.


Our view.  We see continued risks looming and expect dispersion to harshly affect 2022. In this context, differentiation is key to positioning in equities while volatility strategies could offer interesting defensive characteristics. 



[1] Source: Bloomberg.
[2] Source: MSCI indices, Bloomberg. Past performance is not an indicator of future returns.
[3] Source: Bloomberg, MSCI indices. Past performance is not an indicator of future returns.
[4] Cathie Wood is an investor favouring growth stocks while Warren Buffett typically orients investments towards value.
[5] Source: Bloomberg. Past performance is not an indicator of future returns. Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.
[6] Unfunded growth companies are typically reliant on external financing and their valuations depend on future profits.
[7] Any reference to a specific company or security does not constitute a recommendation to buy, sell, hold or directly invest in the company or securities. It should not be assumed that the recommendations made in the future will be profitable or will equal the performance of the securities discussed in this document.

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