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It’s a tough call on who took a bumpier ride this summer: visitors to the season’s fairgrounds and midways or those invested in August’s tumultuous markets.

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A case can be argued for the investors. Economic fears fuelled by trade tensions were reflected in the markets last month — including one volatile day mid-August when the S&P 500 and Dow Jones fell 2.93% and 3.05%, respectively. Stocks have since rallied, but so has the trade war, with retaliatory tariffs by China and tariff increases by the U.S. both announced in the last half of the month.

Yet, the pros are taking the ride in stride. “While this type of volatility can be startling when it occurs, it’s been the norm historically,” said Peter Hardy, senior client portfolio manager of global value strategies at American Century Investments, in an Aug. 22 interview. “We have seen a period of abnormally low volatility, and over the last year we’ve just returned to a period of more normal volatility — not even high, but normal.”

The bumpy ride has resulted in markets hitting record highs this year, while one-year returns are flat. As of Aug. 31, the one-year performance of the S&P/TSX Composite and S&P 500 was a dismal 0.2% and 0.7%.

In contrast, Hardy said his team, which manages the Renaissance U.S. Equity Income Fund, is up 7% over a one-year period by protecting on the downside. “Volatility can be our friend.”

That friendship could continue to be an important one if the U.S. and China don’t play nice when both sides meet in Washington in October.

Valuation considerations

To successfully manage volatility amid trade tensions, Hardy distinguishes between the valuations of individual businesses versus global assets.

With individual businesses, “our approach has always been conservative,” he says. For example, valuation inputs include a company’s normal returns over five to 10 years.

With best-case returns, “companies can be overvalued,” he said.

Further, he analyzes a company’s downside potential for returns to ascertain a downside valuation. Based on the stock’s current trading price, “we can see the discount to its normal valuation and the premium to its downside valuation,” he said.

As a result of his team’s analysis, trade tariffs are put in perspective despite market reaction.

“Increased costs resulting from tariffs, while impacting short-term earnings, do not impact the long-term return-on-capital assumption that we make,” he said. For example, over time, costs can be passed on to customers, and issues related to a company’s geographic location can be mitigated by a move.

U.S. multinational tech giant Intel exemplifies his valuation method.

“Intel’s customers are large computer brands or contract manufacturers in China,” Hardy said. “From a direct tariff standpoint, they would be impacted.”

However, the company has largely built its supply chain in China for China, and has manufacturing facilities in the U.S., Ireland and Israel. “By virtue of that, it mitigates some of the tariff issues associated with Chinese exposure under our valuation approach,” Hardy said, adding that his team remains vigilant with continual evaluation.

At the same time, a trade war is a very real risk to asset prices in aggregate, he said.

Assets are currently overvalued across the board, in part because of accommodative monetary policy, which has allowed companies to take on more debt during a time of stable growth. That time is coming to an end.

“The volatility that we’ve seen over the last year has largely been caused by concerns about global economic growth, which bring into question the sustainability of high worldwide debt levels,” Hardy said. In July, the International Monetary Fund downgraded its previous global growth forecast by 0.1%, to 3.2% in 2019 and 3.5% in 2020.

China’s growth, for example, has been fuelled in part by large increases in debt, which presents an increasing risk to the global economy as trade tensions rise and growth slows.

“We’ve seen volatility come back in the market as the risks have become more evident,” Hardy said, adding that volatility is likely to persist into 2020. His team is prepared.

“Our approach has been one that’s provided protection in periods of market volatility and reasonable returns as the market is going up,” he said. “That is why we have been doing well.”

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