Investment Update

April 2016

Look Before You Leap

Do you know the story about the man
who tries to catch the ferry? Believing
he has missed the boat as it is pulling
away from the dock, he leaps over
a watery gap of four feet and lands
awkwardly on the ferrys deck. Out
of breath but relieved, he soon finds
himself confused when the ferrys
purser runs up to him and says you
fool, were docking! Like the fabled
ferry, volatile markets also cause many
to leap to decisions based on emotion,
especially at what sometimes turns out
to be a very important turning point.
Brought on by concerns about the
strength of the global economy and
extreme investor pessimism, the volatile
start to 2016 drove many equity markets
near or into bear market territory. A
subsequent rally began mid-February
from severely oversold conditions as
it became clear that the U.S. was not
headed for a recession. As is common
during volatile market environments,
investors were quick to react to negative
headlines, feeding the tendency to
panic when things seem at their worst.
In investing, however, it is important
to avoid making emotional decisions.
Instead, one needs to examine the big
picture and adhere to an investment
strategy based on long-term goals that
permits the flexibility to capture shortterm market opportunities.

Money Follows Fear

Bull market corrections are common,
with those not associated with

Figure 1Net Mutual Fund and ETF Flows

Equities vs Bonds
$BILLION

40
30
20

28.4

30.3

2015

33.1

17.5

2016

17.0

15.4

11.7

11.0

10
4.9

6.9

7.0

5.0

6.3

7.6

6.2

1.5

7.7
5.8

0.8

0
-1.3

-0.6

-2.2
-5.6

-10
-10.8
-14.0

-20
-30

-18.2

-18.1
-25.2
Jan

Feb

Mar

Apr

May

Equity Funds

Jun

Jul

Aug

Sep

Oct

Nov

Dec

Jan

Feb

Bond Funds

As of 2/29/16
Source: StrategasRP

recessions happening every 2 1/2 years on average. This recent growth scare
and resulting selloff took investors on a wild ride that led many to leap to the
conclusion that the U.S. economy was destined for a recession. Many investors,
however, were misinterpreting the signals. They abandoned stocks and moved
to safe-haven investments on fears of weaker-than-expected global economic
growth. Exhibit 1 shows this pattern of investors running from poorly performing
equities on what turned out to be the August 2015 low. That pattern repeated
itself in both January and February of 2016, as more than $18.8 billion came
out of equity mutual funds and exchange traded funds, and $19.4 billion moved
into bonds during this most recent turndown.
Exhibit 2 looks at this same issue utilizing sentiment data. The CBOE Volatility
Index (VIX), often referred to as a gauge of investor fear, is a measure of implied
market volatility. It spiked in August and again in the first two months of 2016.
This pattern of extreme sentiment can also be seen in the Ned Davis Research
crowd sentiment poll, which asks investors if they are bullish or bearish and
typically reaches extremes at market turning points. Not surprisingly, both these
indicators are used by professionals for their contrary signals. In other words,
when everyone is bearish, it is a better time to be a buyer than a seller,
as most sellers have already left the market.

Figure 2Investor Sentiment Contrary to Volatility

A Plan for Future Volatility

CBOE Market Volatility Index (VIX) vs. Ned Davis Crowd Sentiment Poll

Just as we advised clients not to

overreact during the January/February
selloff, which had all the bad news
already priced in, investors should
not change their investment strategy
just because the skies look clearer.
We continue to expect that slow
global growth, divergent but largely
accommodative monetary policy, and
low inflation will be supportive of equities
moving eventually higher. While many
of the risks that dominated the first
few months of the year have somewhat
subsided, we are not yet safely ashore.
Volatility will likely remain a prevalent
theme throughout the year with issues
such as Brexit (a possible exit of the U.K.
from the European Union), continued
weakness in corporate earnings, political
uncertainty and geopolitical tensions all
adding a source of uncertainty.

INDEX LEVEL

Aug 25
2015

45

Sep 28
2015

Feb 11
2016

40

70

65

35

60

30
55
25
50

20

45

15

40

10
Jan-2015

Mar-2015

May-2015
VIX (Left Axis)

Jul-2015

Sep-2015

Nov-2015

Jan-2016

Mar-2016

Ned Davis Crowd Sentiment Poll (Right Axis)

As of 3/22/16
Source: StrategasRP

These flow patterns repeat themselves through time because many investors
misread economic signals. At BNY Mellon Wealth Management, we meet
frequently to assess global events and analyze economic data. We concluded
that slower growth in China would not pull the U.S. economy into a recession.
Instead, we believed this was more of a soft patch and that better-thanexpected economic data would follow. Furthermore, the Fed recently lowered its
expectations to raise rates in 2016 from four to two, which is more in line with
what we and the market anticipate. Even commodities, and oil in particular,
have rallied as the weakening of the U.S. dollar and hopes of a production
freeze have served to steady prices.

A Selloff Followed By Recovery: Now What?

I often get asked whether it is right to stay the course when the markets get
bumpy. My answer is that staying disciplined and adhering to your investment
plan is the right course of action if the underlying reasons for a selloff are
unsupported by market and economic data, and you have taken the time to
plan in advance of volatility. We predicted subdued returns and heightened
volatility in 2015 and proactively positioned client portfolios for this market
backdrop. We have a slight overweight to equities offset by a slight overweight
to diversifiers (or those investments that dont move in the same general
direction as stocks or bonds). If we see even greater equity weakness without
a corresponding deterioration in economic fundamentals, you might even see
us begin to buy in order to take advantage of oversold conditions. Just as we
took steps to protect portfolios in advance of the downturn, we continue to
seek opportunities that can help clients achieve their long-term goals.

Although it is easy for many investors

to lose sight of proper investment
discipline, usually because of emotion,
it is imperative to set a course of action
in advance. After all, market volatility
presents opportunities to either make
mistakes, or take advantage of the
mistakes of others. In the end, discipline
can help investors look before they leap.

Jeff Mortimer, CFA

Director of Investment Strategy

This material is provided for illustrative/educational purposes only. This material is not intended to constitute investment or financial advice. Effort has been made to ensure that the material
presented herein is accurate at the time of publication. However, this material is not intended to be a full and exhaustive explanation of all of the investment or financial options available. The
information discussed herein may not be applicable to or appropriate for every investor and should be used only after consultation with professionals who have reviewed your specific situation.
BNY Mellon Wealth Management conducts business through various operating subsidiaries of The Bank of New York Mellon Corporation.

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