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Opinion

Against the Tide: Go long volatility for the next 12 months

Less liquidity in equity markets suggests that investment strategies harnessing volatility are appropriate.

The big fall in global equity markets in May and early June has given investors something to think about. After a rally in markets since October 2002, equities had by June 10 fallen from their peak on May 9 by more than 11%. Since this is more than 10%, technical analysts like to call it a correction.

Japan and Europe fell by 17% and 12%, respectively, much more than the US (down 6%). But it was emerging markets that took the biggest hit, down 20%. Of the sectors, basic resources, industrials and energy were most adversely affected, while more defensive sectors, such as health and utilities, enjoyed relative outperformance.

That indicates that the markets that did best in the four-year rally (Europe and Asia) and also demanded the biggest risk appetite (emerging markets) took the biggest fall.

For some time, I’ve been pushing hard with my clients the thesis that the great rise in asset prices (equities, property and commodities) has been driven above all by monetary forces.

Liquidity is the lifeblood of equity markets and global economies. In the past decade or so, that liquidity has been amplified by the securitization of debt and derivatives.

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