Stock markets across the globe have just emerged from a short, sharp shock, with the sell-off on 5 August one of the worst days in years as investors mull the frightening thought that the US economy is slowing and could be sent spinning into recession.

Combined with the impact of the unwinding in the yen ‘carry trade’ discussed in this explainer and some stretched valuations and you had the recipe for some alarming market turmoil.

If investors needed reminding of the capricious nature of financial markets, they’ve had it in spades over the past 10 days or so. It’s been bonkers and the frenzy has left many feeling panicked about their portfolios and pondering the question: should I sell too?

The previously high-flying Nasdaq Composite fell into official correction territory, having lost around 12% since mid-July, while the S&P 500 and Dow Jones have dropped off too over that timeframe.

In the UK, the FTSE 100 and mid-cap FTSE 250 have also struggled while the Euro Stoxx 50 is down markedly. That’s nothing compared to Japan, where the Nikkei 225 has been smashed, has been flirting with bear market territory. And analysts have been lining up arguments why ‘the dip may not be a blip’.

‘Though we describe a low double-digit correction there is also risk of a bear market if the slowdown becomes a recession which, by history and definition, would be a surprise to investors and the Federal Reserve,’ analysts at Stifel said.

Goldman Sachs said investors have grown complacent, interpreting negative news as positive, relying on potential interest rate cuts and the robust earnings of large-cap AI (artificial intelligence) companies to offset broader economic sluggishness.

‘High valuation and rising US unemployment from a low level are two of the components that are most stretched and suggest that we are not out of the woods yet’, Goldman’s team said. At least they, for now, are ruling out an outright global bear market, saying that outcome ‘remains unlikely’, an opinion shared by Citi’s analysts, who recently emphasised that a fully-fledged bear market, defined by a 20% drop, is ‘unlikely at present.’

Even so, that’s likely to be cold comfort for ordinary investors staring at potential double-digit losses.

WHAT CAN INVESTORS DO?

This first and most important thing to say is, DO NOT panic. As our box on ‘volatility’ explains (below), sudden lurches in stock markets are nothing new and must be accepted as normal business by active investors. These periods are always uncomfortable, but they can serve a valuable purpose, such as:

• Resetting market expectations when optimism has become too exuberant
• Because intense volatility impacts almost all stocks and funds, these spells can throw up attractive entry points to new stocks, or opportunities to top-up existing holdings
• Provides investors with a trigger to reassess their portfolios and get them shipshape for the months ahead

According to Citi strategists, while these fluctuations might unsettle investors, they are not unprecedented. Historically, the S&P 500 has undergone 5%-plus pullbacks three times a year on average since the 1930s, with larger corrections occurring less frequently.

Remaining invested in the market has historically been the best course of action if you’re in it for the long haul. Stock markets tend to recover faster than you think, although precisely predicting when that may happen is impossible.

Investors might ask whether the fundamentals have changed for your investments, and if they haven’t deteriorated, it’s probably best to do nothing. If they have, you need to do further research and ask whether you should still own that investment.

But it is also advisable to remain open the possibility that for many good quality companies, little has really changed except the valuation. That could mean a rare chance to invest in a business at a price discounted to levels seldom seen.

That said, it is natural for investors, especially more cautious ones, to consider investments with lower levels of volatility relative to the market, or low-beta stocks and funds. We’ll come to low-beta stocks in a bit, but first, let’s look at some fund options.

LOW-VOLATILTY FUNDS

As you can see, there are plenty of low-cost, low volatility ETF options to choose from. Just ETF lists 22 low-volatility ETFs, across Global, US, and Europe, and including some ESG slanted options too, although some of the funds are very small – the Invesco Quantitative Strategies Global Equity Low Volatility Low Carbon (LVLG) ETF has just £1 million in assets, according to Just ETF. 

So, what sort of stocks will you find in these funds? Looking at two of the biggest global ETFs – iShares Edge MSCI World Minimum Volatility (MINV) and Xtrackers MSCI World Minimum Volatility (XDEB), top 10 holdings are identical, with barely any change between stake sizes relative to the scale of the fund, with mobile telco T-Mobile US (TMUS:NASDAQ), communications kit manufacturer Motorola (MSI:NYSE) and waste disposal operator Waste Management (WM:NYSE) the top three holdings in both funds.

Both are also heavily weighted to the US, where about 62% of the funds are invested, followed by Japan and Switzerland – no change there either, just as in sector exposure, both in the Technology, Healthcare and Financials sectors by equal measure.

Where they do differ is scale, plus cost and performance. The iShares Edge MSCI World Minimum Volatility ETF is by far the bigger of the pair, with more than £2 billion in assets. By contrast, the Xtrackers MSCI World Minimum Volatility has a more modest £372 million of assets, although scale isn’t really a selection factor, not at these sorts of levels.

Cost and performance are. The iShares fund is more expensive, with ongoing charges pitched at 0.3%, which is still reasonably low compared to many factor ETFs but not as low as the Xtrackers option, which has an ongoing charge of 0.25%. Such cost differences may appear almost insignificant, yet they can have a big impact over many years, so it’s worth bearing in mind, especially given that fund performance is close on identical, unsurprising given the make-up of their respective portfolios.

If low volatility ETFs are not for you and you’d prefer to be more hands on with low beta stock selection, there’s even more options to choose from.

LOW-BETA STOCKS

To help investors identify some stock ideas which might avoid the worst of any near-term volatility Shares has run the numbers to find stocks which have a materially lower beta than the market.

When we talk about beta we’re referring to a ratio which measures the extent to which a stock moves when the market rises or falls by 1%. The starting point is the market has a beta of 1. So, if a stock has a beta of 1.5, it will move 1.5% for every 1% move in the market, while a share with a beta of 0.5 will move just 0.5% in the same scenario.

On this basis, low-beta stocks could afford you some protection against any further wild swings in financial markets.

Using Stockopedia we screened the FTSE 350 to find stocks with a beta versus the FTSE All-Share of 0.75 or less. You can see a selection of those names in the table below. It is unsurprising to see sectors like health care, utilities, supermarkets and consumer staples well represented as these typically have more predictable revenue and earnings streams and are somewhat less tied to the fortunes of the wider economy.

However, low beta on its own might not mean a stock has defensive qualities. It could simply mean the shares trade less frequently. Plus, this is based on historic data, the beta can change, and a stock which has historically been low beta can become high beta if it undergoes a material change in circumstances. Finally, you should not invest in something just because it is low beta, it is worth considering the inherent qualities of the underlying business. Water utility Pennon (PNN) is low beta but has been a pretty hopeless stock market performer in recent times – the shares falling more than 40% on a five-year view.

With this in mind, we have applied our own knowledge and some number crunching to the individual names on the list to identify two shares which represent great investments in their own right as well as being potentially less exposed to market fluctuations. [TS]

SELECTED LOW-BETA FTSE 350 STOCKS

London Stock Exchange Group (LSEG) £97.34

Beta: 0.37

It may be best known for its eponymous stock exchange but the company has, in the words of Berenberg analyst Peter Richardson ‘completely reconfigured its business model since 2007’. When operating the stock exchange was its main area of business, performance was reliant on the number of companies it could attract and retain as it levied listing fees on exchange constituents. It has now expanded massively into information services, which deliver recurring subscription-based revenue, as well as forging a leading position in OTC (over the counter) derivatives. Derivatives are securities with a price that is dependent upon or derived from one or more underlying assets. When they are bought or sold OTC it means they are traded through a broker-dealer network rather than on a centralised exchange. As Richardson explains: ‘This new model exposes it to some of the strongest structural trends in the finance industry: ETF (exchange-traded fund) penetration, OTC clearing, greater risk management and quant investing.’

A new data collaboration with Microsoft (MSFT) also holds significant potential for the business. Given these strengths a valuation of 24.3 times consensus forecast 2025 earnings does not seem overly demanding. Richardson notes the company has received a takeover approach every two-and-a-half years since listing in 2000, implying bid interest could come to investor’s rescue in the event of share price weakness. [TS]

AG Barr (BAG) 616pBeta: 0.67

While in the very short term its sales can be dependent on the weather AG Barr (BAG) benefits from the same resilient demand as larger soft drinks players like Coca-Cola (KO:NYSE) and PepsiCo (PEP:NASDAQ).

Even if the economic outlook is uncertain, people are less likely to cut back on impulse purchases of little treats like a can of fizzy pop.

AG Barr is best known for its Irn-Bru – Scotland’s favourite fizzy drink – but it also has other successful brands such as Rubicon and Snapple.

While it might represent a ramping up in terms of competition, Carlsberg’s (CARL-B:CPH) takeover of Barr’s counterpart Britvic (BVIC) has a positive read across for the company’s valuation. According to Liberum, Carlsberg paid an historic EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) multiple of 13.6 times. This compares with an historic EV/EBITDA of 10.5 times for Barr.

The company has scope to increase margins, after a period when they have been constrained by cost inflation and is sitting on a cash pile of £54 million. Liberum analyst Anubhav Malhotra says the cash generative business could sustain a net debt to EBITDA ratio of 2.5 times which applies as much £250 million firepower which could be put towards acquisitions or M&A. [TS]

VOLATILITY EXPLAINED

Markets need to ‘reset’ from time to time before they can move higher. You have probably heard market commentators use the word volatility a lot over the last few weeks, and with good reason. Most of the time, share prices tend to move higher with little fanfare and that has certainly been the case over the last couple of years.

Post-pandemic daily movements in the FTSE 100 and the S&P 500 have been less than 1%, and very infrequently have they reached 2% or more, with the effect investors have been lulled into thinking there is nothing to worry about. Add to that our instinct to extrapolate the recent past into the near future and there seems no reason to expect share prices to suddenly collapse, yet out of the blue they have and with alarming speed.

The root cause of the sell-off was traders unwinding the yen carry trade following an increase in Japanese interest rates, but this happened at a point in time where volatility had been exceptionally low for a long time.

Volatility in the S&P 500 is measured by something called the VIX index, which is the annualised implied movements of a hypothetical S&P 500 option with a life of 30 days. In a nutshell, the price of the VIX reflects how much the index is seen moving during the next 30 days – the higher the value, the more implied volatility.

Over the last two years, the VIX index has been steadily declining, implying lower volatility and allowing the S&P 500 to add over 2,000 points or 58% from its low in October 2022.

The FTSE 100 has only added 22% from its October 2022 low, but the good news for investors is volatility in the index is about half that of the S&P 500 – over the last two years it has only moved 1% or more 13% of the time against 25% of the time for the US benchmark.

A key reason for this is the make-up of the UK market, which has a greater weighting in consumer staples, healthcare, oil and gas and utility companies, whose earnings tend to be less volatile, whereas the US has a high weighting in technology companies, whose earnings can be much more volatile.

So, while the last couple of weeks may have been hair-raising, the damage to the UK market has been less severe meaning it doesn’t need to recover as much lost ground. (IC)

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