Volatility demands active management

In a world where volatility is the new normal, getting the right asset mix and sector-rotation can make the difference between capital gain and loss.

“You have got to be an active manager,” said John Zechner, chair and CEO of J. Zechner Associates Inc., speaking at the CIFPs 9th Annual National Conference-2011, in Ottawa. “Markets will never go straight up and that’s what money managers must tell their clients, too.”

While conceding that buy and hold is not quite dead, he said that strategy in a volatile world is changing. “There’s going to be [frequent fluctuations] happening all the time,” he said. “Markets will go up and down, there’s too much flow; the information disseminates too quickly.”

The market is quick to react to opinions shared by industry experts on television, he added. “You can see it immediately the way things are going to move back and forth.”

Zechner is particularly concerned about investors’ reaction to negative news. “People sell first and they ask questions later,” he said. “This industry has a bad impression, because it’s about money, and it’s about greed, and that’s the reality of it.”

Asset allocation, not market timing, has a huge ability to add value longer term, he asserted. “Markets will always be volatile; that’s why we make our money by trying to see where that volatility is, sell into it and buy when the market’s low.”

And low is where Zechner feels the stock markets are. His current bias is on the upside of stocks. “You’re going to look around in a couple of years and you’re going to say this was a great buying opportunity in stocks,” he said. “Stock valuations are extremely reasonable on a historical basis.”

When there’s an uptick in the economy, market sentiment often gets ahead of itself driving valuations higher, he warned.

“The stock market is a proxy for the growth of the global economy; in order to figure out where the stock market’s going, and the valuation, you have to have some sense of where the global economy is going.”

Zechner likens economies to giant ocean liners. “They gain momentum in one direction and they keep going for awhile; it takes a while to slow it down and it takes a while to speed it up.”

The ocean liner of the global economy has weathered one of the roughest storms in recent history, he said alluding to the global financial crisis of 2008.

“We’ve come through the worst economic crisis that anybody has seen since the 1930s in the U.S,” he said. “I think we’re setting up very well; we’ve gained momentum going forward, [and while] that’s not going to continue at the same rate necessarily, we’re past the worse point.”

The next period of global expansion, the big economic story, is emerging markets which are rapidly industrializing. “This recovery we’ve seen this last year is very unique [in that] it wasn’t the U.S. that led the global economy, it was actually China.”

As these emerging economies move from agriculture to industrialized economies, the demand for raw material will continue to rise. “Increased use of basic raw materials, copper, iron ore, cooking oil, oil and gas, uranium, [indicates that] the demand for commodities is growing strongly.”

Emerging economies, he said, are now big enough to carry global commodity consumption on their own. “No one could predict the future but on one hand I have three economies—Japan, Europe, and U.S.—and on the other Indonesia, India, China, South America, Africa, Eastern Europe—the emerging economies of the world.”

It is easy to call which one is going to grow faster over the next 10-20 years. As a bullish long-term story, emerging markets, and especially their appetite for commodities, are an attractive proposition.

After two decades of underinvestment, a lot of money is now flowing directly into commodities. “Commodities did nothing for 20 years, and the tech bubble ended, [so] commodities started to rise and it’s probably going to be a 20-year bull market.”

He uses oil as an example to rationalize his theory. “We’re not out of oil in the world; we’re out of cheap oil,” he said referring to the increasing costs of extraction.

As supplies get more expensive, they get more restrictive leading to reduced supply, increased demand and higher prices. On top of all that, he said, all commodities are priced in U.S. dollars, a steadily weakening currency.

“By extension, [when] the dollar falls, the value of commodity price goes higher; it’s an easy story to understand,” he said.