While the recent rally in equity indexes is encouraging for institutional investors, the risk-on/risk-off behavior that characterized market performance during 2011 is unlikely to be quickly forgotten. During this time, it appeared that the market was no longer willing to differentiate between specific companies, preferring to trade stocks as if their underlying fundamentals were almost identical.
The resulting correlations between stocks have, therefore, remained consistently elevated, and not just in 2011. That trend has persisted since 2007 and across all global stock markets. Throughout that period we have seen the increasingly dominant role of macro-driven views — or concerns. This has been driven by the rise of global macro hedge funds and absolute-return products and exacerbated by the growth of exchange-traded funds.
While some semblance of normality might be returning to traditional long-only equity strategies, the underlying structural reasons for elevated correlations in equity markets remain in place. In this environment, it is important to examine the drivers of recent volatility and consider the implications for fundamental stock pickers.
Even with these shifts in recent years, the companies and businesses behind the stock market continue to develop and behave in more conventional ways. We believe that, while short-term swings in macro sentiment might affect stock prices, it is inevitable the underlying realities of corporate business performance will eventually be reflected through financial results or company actions. Ultimately, it is these factors that underpin share price performance.
We believe the unprecedented volatility during 2011 actually serves to strengthen the case for a fundamental stock-selection approach. Indeed, we would argue that in an environment where a greater proportion of market participants are overlooking stock specifics in favor of macro drivers, returns available to stock pickers should be enhanced.