• The recent spike in volatility has been caused by US Tech stocks coming off very expensive valuations as they start to fall short of earnings expectations
• Volatility is normal – the UK stock market sees an average drawdown of 15% in any given year, however, the market still finishes positive 65% of the time
• Bowmore utilise the correlation benefits between different asset classes to smooth out volatility

It’s no secret that volatility has spiked over the past couple of weeks, indeed we addressed it in an ad-hoc note earlier this week. Today we wanted to flesh out the reason behind this recent volatility more, but also explore the topic in a more general sense and how it informs our portfolio construction.

Recap on what happened

The magnificent seven were responsible for approximately two thirds of the S&P 500’s gains in the first half of this year, climbing to lofty valuations. This share price appreciation was driven by primarily two things: bullish investor sentiment and earnings expectations. The below chart is not what the share prices did over the last year, it is how analyst earnings expectations have changed.

Source: Ninetyone, Navigating an increasingly concentrated market

Naturally, as we saw these two major factors unwind, so did the share price gains. A fear of recession borne from weaker economic data created the shift in investor sentiment. Meanwhile, earnings, which had been brilliant up until this latest earnings season, started to slow down and gave investors a bit of a reality check. Amazon had a revenue miss and Microsoft also talked about demand not meeting expectations. Just as these mega-cap tech companies were responsible for the gains in the first half of the year, so too were they responsible for the recent sell off, creating that spike in volatility:

Source: JPMorgan, Market Watch

Volatility is normal

Source: JPMorgan, Guide to the Markets

The above chart shows in red the largest drawdown from peak to trough the UK stock market saw in a calendar year, whilst the grey bar shows the final return for the market in that year. There is an average drawdown of 15% in a year, however, the market still finishes positive in 65% of the years. In fact, there are multiple years where the market falls by more than 20% and still finishes up. There’s also never a year that doesn’t see at least a 4% drop.

The point here is that markets do trend upwards over the long-term and it’s important to retain a long-term view when investing in Equity markets, particularly during bouts of volatility. Recoveries can sometimes be very quick or a bit of a drawn-out process and missing the best market days can be very punishing for long-term performance. During the pandemic we saw a very sharp recovery after the dip in March 2020 that rallied through the rest of the year, whilst 2022 saw a more prolonged draw down before the recovery in 2023.

Bowmore portfolios and reducing volatility

One of our primary goals as investment managers is to smooth the investment journey for clients and avoid large spikes in volatility (and any sleepless nights). We do this by building multi-asset portfolios with asset classes, sectors and geographies that have different correlations. In the last month we have seen this play out in a few different ways. Firstly, July 11^th saw the start of the sell-off in the S&P 500 (US Large cap), however, we have an active overweight position to US Small cap which benefited from this rotation and muted our portfolio drawdown. The below chart shows how our US Small Cap fund performed as the S&P 500 ETF we hold slid:

Secondly, as we mentioned in our note earlier in the week, the Gilts and other fixed interest we hold, greatly benefited from the equity sell off as the fear of recession increased the expectation of rate cuts (which is good for bond values). What this has all meant is that not only have absolute returns been strong, but volatility has been managed in the 3 months to end of July: