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Market Signals Amidst The Noise

In the past quarter, two major market signals continued to show evidence of a slow return to more conventional behaviours in global financial markets: decreasing correlation of stock price changes and reduced volatility of investment prices. Both of these developments indicate the beginning of a return of what we have called the “old normal” to global financial markets.

Why are these signals important? Markets need differences of opinion in order to function effectively: when a security is sold, there must always be a buyer. Built into the price that each is willing to accept is a view of both return potential and risk. When uncertainty is high about return and risk indicators, there is an increase in the variation of price changes over time–this is investment volatility. When a common belief dominates the thinking of investors, we see the prices of a majority of stocks move in the same direction, and a high correlation is the measured result. The levels of both market volatility and correlation have diminished, edging closer to the levels of a more normalized market environment.

Although the signals are turning positive, we still pay close attention to the investment details. At MD, we build diversified portfolios which look to combine assets to properly manage correlation. This methodology is designed to expose our investors only to the amount of investment risk appropriate to their purpose and time horizon.

For the past several years, global financial markets have been operating without the clarity of normal market signals. As a result, they have been inherently less stable, as investors have swung alternately towards or away from risky assets en masse. We have described this “risk-on/risk-off” phenomenon as the “new normal” for global financial markets. In this environment, the main signals for investors have been the actions of policy-makers around the world.

As we see the return to the “old normal” we expect the opportunities for outperformance by active investment management to be more abundant. Our investment managers continue to use their research to find good companies and to create portfolios that meet the needs of our investors. While we know that elements of the global economy are still fragile, as we round out this first quarter of 2013 we are heartened by the evidence we see of the re-emergence of the “old normal.”

William R. Horton, Jr., CFA
Chief Investment Officer
MD Financial Management Inc.

MD Financial Management Inc. Chief Investment Officer William Horton Jr., CFA, recently appeared on BNN’s Market Sense to discuss MD’s experience adding alternative investments to the asset classes available to MD investors through two new investment pools, launched in February. He also discussed MD’s current tactical asset allocation, including “tilts” implemented over the past quarter to increase exposure to equities, especially in Europe, Asia and the Far East.

Watch Health of the Markets.