Creating a Nightmare on Wall Street?

Call it sleep insurance.

When the economy is soft and markets are sagging, investors are often willing to pay up for price stability. The higher multiples seem like a reasonable tradeoff to those who are wary of downside volatility and want to sleep without the fear of losing money. But what happens when the same approach is used in up markets when the economy is growing? Does sleep insurance turn into a recipe for nightmares?  

Correlation of High Momentum and Low Volatility
12/31/1985 to 7/31/2016

Heartland Advisors Value Investing Market Insight Correlation Between Momentum and Volatility Chart

Source: The Leuthold Group utilized their Leuthold 3000 Index to show correlation of the current rank of high momentum versus low volatility stocks. Momentum is measured using a composite of 9, 12, and 12-1 month performance. Volatility is measured using the trailing 1-year standard deviation of stock price. Leuthold 3000 Index is defined as the 3000 largest securities that trade in the U.S. (includes American Depository Receipts).

This chart leads us to believe the answer may be here sooner than expected. It shows that the correlation between low volatility and high momentum factors is at levels usually seen near market bottoms. This matters because in the past, when correlations began to subside, low volatility stocks fell quickly. Given the significant overlap between low volatility and dividend paying bond proxies, the effect could be particularly painful. If rates rise, investors may abandon dividend yielding equities, adding additional pressure to many low volatility names.

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Heartland Advisors Value Investing Portfolio Manager Colin McWey

Colin McWey

McWey, CFA, is Vice President and Portfolio Manager of the Select Value and Mid Cap Value Funds and their corresponding separately managed account strategies. He has 15 years of industry experience, 8 at Heartland.

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