Yahoo Finance Why Richard Fisher thinks volatility can be good for investors
The Dallas Fed's Richard Fisher shares key forward guidance (Part 10 of 10)
Volatility
In his speech at the London School of Economics, Dallas Fed president Richard Fisher said he believed the Fed had made “the life of money market operators quite easy” by taking “volatility out of the marketplace.” He commented, “When you move in one direction, it is pretty easy for people to assume that that direction will continue forever.”
Fisher further said that maintaining and suppressing rates for a prolonged period has generated an environment of complacency, and it’s a natural instinct to drive people to take greater risk. As long as it’s not extreme or destabilizing, more volatility in the market is healthy. Fisher says he “personally has no qualms about injecting a bit more volatility into the marketplace particularly now when we’ve bought time away from the most severe crisis imaginable” certainly since the Great Depression.
How can investors deal with uncertainty in markets?
The Fed’s shift from quantitative to qualitative guidance will inject more uncertainty in the markets, as investors keep debating the language and spirit of the Fed’s communiques. Secondly, the question of uncertainty lies in the “when” rather than the “if” at this stage—that is, when rates will increase and by how much. The Fed has kept its base rate at the lowest levels in 237 years (0% to 0.25%) and also for the longest time (since December 2008).
Rising interest rates would mean falling bond prices. In a rising rate environment, fixed income investors can profit by investing in floating-rate ETFs like the Market Vectors Investment Grade Floating Rate ETF (FLTR). The interest rates on floating rate notes aren’t fixed but are reset at periodic dates based on a market reference rate. So if rates rise, investors get the benefit of the higher rates.
Investors can also benefit by investing in inverse bond ETFs like the ProShares Short 20+ Year Treasury Fund (TBF). Inverse bond ETFs provide returns inverse to or opposite of the underlying benchmark index, which would benefit these ETFs as the Fed begins normalization and monetary tightening and rates rise.
With rates expected to rise, and the S&P 500 Index (SPY) entering its sixth year of the bull market and at near record-high levels, ETFs that invest in low beta sector stocks would be a safer bet. These stocks show lesser correlation with the upturns and downturns in the benchmark index and would be impacted to a lower degree should the benchmark index fall, other factors remaining constant. ETFs such as the Invesco PowerShares S&P 500 Low Volatility Portfolio (SPLV), which tracks the S&P 500 Low Volatility Index consisting of the 100 stocks from the S&P 500 Index have the lowest realized volatility over the past 12 months. The top ten holdings in SPLV include utility company Southern (SO) and financial company U.S. Bancorp (USB).
To learn more about credit ratings and associated risks in the fixed income market, see the Market Realist series Credit ratings: Another bubble in the making?
Browse this series on Market Realist:
