THE WEEK AHEAD: Investing in volatile times

After beating a retreat in the early months of the year, volatility returned to the sharemarket with a vengeance in May. In the 21 trading days of May, the All Ordinaries either rose or fell by more than one percent on 15 occasions. That was the most volatile period since the height of the US financial crisis in November 2008.

Some investors – namely traders – don’t see the lift in volatility as a bad thing. Clearly if the market is moving and you pick the trends right then there are more opportunities to make money. Clearly longer-term or ‘buy and hold’ investors have a decidedly different view – concerned at the daily fluctuations in the value of their portfolios.

This is where knowledge of the ‘beta’ of stocks may come in handy. Essentially beta refers to the extent that a company’s share price moves in line with the market. If the stock is essentially more volatile then it will have a high beta while companies that have a low beta may see little movement in their share price when the market is moving.

No ratio or approach is fool-proof but it is interesting to have some idea of the beta values maintained by stocks in a portfolio, especially if you have a view about where the market is going and are seeking to maximise potential gains or to protect against losses.

Some investors may feel that if they have holdings covering the biggest companies the market, that they have greater protection from sharp swings in the broader market. The S&P/ASX 20 (biggest 20 stocks) covers just 10 per cent of stocks in the ASX 200 but represents two-thirds of capitalisation of the broader index. But the prominence and importance of the top 20 stocks don’t translate to low volatility. In fact according to the data from Bloomberg, beta values of the top 20 stocks range from 0.523 (Telstra) to 1.299 (BHP-Billiton). Eleven of the 20 stocks have betas below 1.0 compared with the ASX 200 index while the remainder have betas above 1.0.

What about the S&P/ASX 50 – an index that represents 83 per cent of the capitalisation of the ASX 200 index? A similar proportion of the companies – that is, 28 of the 50 stocks – have beta values below 1.0. But the betas also cover a greater range of 0.416 to 1.497.

As would be expected, stocks in the resource sector tend to have the highest betas, led by Fortescue (1.497) and Worley Parsons (1.474) but interestingly GPT (1.426) is also near the top of the rankings. Steel stocks like BlueScope (1.415) and OneSteel (1.375) also have high betas. At the other end of the scale are telecom and food stocks, including Coca Cola Amatil (0.416), Telecom NZ (0.531) and Telstra (0.523). Suncorp-Metway (1.003) and Orica (0.994) are more likely to track the broader market.

The week ahead

Economists have been starved of data over the past fortnight and the situation is not going to improve greatly over the coming week. While there is a spattering of indicators to be released, they are heavily concentrated over Wednesday and Thursday.

On Wednesday, figures on lending (private sector credit), job vacancies, new home sales and home prices are released. And on Thursday the Performance of Manufacturing index, retail trade and building approvals data for May are slated for release.

Ordinarily the retail spending and building approvals figures would dominate attention. And while that is certainly the case again in the coming week, there will also be plenty of interest in the home price data. In April, prices just edged 0.2% higher – the lowest reading in four months. Another modest result would be well viewed. It would suggest that recent rate hikes are working to slow housing demand and that the housing market is on track for more sustainable annual price growth of between 5-8%. While home buyers would celebrate slower price growth, they would also be able the Reserve Bank likely staying on the interest rate sidelines for longer.

The chances of the Reserve Bank leaving cash rates stable would get a further boost if retail spending remains sluggish in May as most retailers are reporting. Overall we expect that sales rose just 0.3% in May after posting growth of 0.4% over the previous five months. The era of “new conservatism” doesn’t look like ending any time soon as retailers are forced to keep discounting to move goods from the shelves.

Building approvals may have edged 2% higher in May, but given the volatility of the series, clearly we don’t hold the forecast with much certainty. Still, approvals look to be flattening out in a 14,000-14,500 range, lifting annual approvals near 170,000. If this outcome is sustained it would go a long way in stemming the perceived shortfall of houses and apartments, especially if activity was concentrated in NSW and Queensland.

Turning to the US, the main interest is in the non-farm payrolls data on Friday. And after the weaker than expected performance in May forecasts are centred on around 75,000 jobs being lost in June. The temporary hiring of census workers over the last few months has added a degree of volatility to the labour market results. And for a better indication of the recovery on the employment front, analysts will look to the change in private sector payrolls, where 120,000 jobs is expected to be created up from just 40,000 last month. The jobless rate is expected to remain steady at 9.7 per cent.

Of the other indicators, personal income & spending will be released on Monday with the Case/Shiller home price series and consumer confidence on Tuesday. The ADP employment index is issued on Wednesday with Chicago purchasing managers survey. On Thursday the Challenger job lay-offs series is released together with the ISM manufacturing index, car sales, pending home sales and construction spending.

A sharp slide is expected for pending homes sales (-20.0%), as the expiry of the home buyer tax credit results in a hangover effect taking place. Similarly softer results are tipped for the ISM Manufacturing Index (59.1 expected), consumer confidence (62.8 expected) and total vehicle sales is expected to drift marginally lower.

Sharemarket

One factor that can complicate analysis of global sharemarket performance is the movement in currencies. As a result, global fund managers, including hedge funds, tend to track performance in a common currency – namely the US dollar. And looking over the past year the majority of major global sharemarkets have posted healthy gains. Of the 44 sharemarkets tracked by FactSet, all but five have recorded solid gains over the past year. Indonesia leads the gains, up 65%, followed by Argentina and Turkey. The US sharemarket has lifted 29%, ahead of Australia, up 26%, and the world index, up 23%.

One factor holding Australia back in recent months has been the performance of the resource sector. Since the end of March, the Non-energy minerals sector has fallen 13% in US dollar terms, versus gains of 20% in the US, 6% in Canada, 4% in Chile and a flat performance in South Africa.

Interest rates, currencies & commodities

The big story over the past week was the decision made by the Chinese central bank to allow its currency to fluctuate again. From 2005-2008, the Chinese Yuan was allowed to move up to 0.5% on a daily basis, the end result being a near 18 per cent appreciation against the greenback over the period. The exchange rate policy was suspended at the height of the global financial crisis. But now Chinese authorities believe the time is ripe for the process of daily exchange rate adjustments to begin again.

The move is potentially positive on a number of fronts including defusing trade tensions with the US, and boosting household spending and restraining inflationary pressures via cheaper imports. The path of currency appreciation is likely to prove gradual, as was the case from 2005-2008. But the fact that Chinese authorities have re-started the process is yet another sign that the global economy is on the mend.

Australia is potentially a winner from Chinese currency appreciation as well. If the Yuan strengthens, then Chinese businesses have greater purchasing power to buy our raw materials. The important point in all this is the word ‘potentially’ – there’s always the risk of other things coming from left field.

Craig James is chief economist at CommSec.