Why stock markets will stay volatile – and how to make money from volatility

Record highs

Most markets are near record highs, point at which more volatility is to be expected. This is exacerbated by many events in world politics. I will highlight three here:

 

Brexit

The UK may struggle to find an amicable exit from the EU, pointing towards a prolonged, business friendly transition period, which has send the FTSE to record highs. The only problem is that a prolonged, close relationship with the EU will not be acceptable to hardcore Brexiteers, which risks leading to new elections, likely to be either inconclusive or ending with an old Trotskyist taking the keys to number 10 Downing Street. The Brexit negotiations outcome is still unpredictable, with only weeks left to find an agreement on the divorce. Thereby the EU’s third largest economy holds a lot of potential for volatility in the UK and wider markets.

 

USA and Donald Trump

Surveys give the Democrats a ⅔ chance to take a majority in both houses at the upcoming mid-term elections in the USA. As this will increase the pressure to impeach Donald Trump with all the mud sliding that goes with it, the compulsive tweeting POTUS45 holds a lot of potential for volatility in the USA, which still sets the pace for global markets. As a side note, one has to wonder how to control that his family and friends are not benefiting from advanced knowledge about tweets which move markets?

 

At the same time, an increasingly protectionist, inward looking US is retracting from Africa and the Middle East. Having gained greater independence in its energy supply, the USA is for the first time in decades in a position to fight trade wars and to strategically withdraw from oil supplying countries. These regions won’t fall into a vacuum, as Iran, Russia and China are all keen to replace American influence. For better or worse, this will change energy markets and investment markets dramatically.

Italy

The European Union and the common currency have made great progress since the real estate bubble burst and caused the last global financial crisis. The “PIGS” economies of Portugal, Ireland, Greece and Spain (though currently under the threat of a no-confidence vote) are growing, unemployment had been reduced, public finances are in better shape and so are most European banks. Except for Italy, where little has been achieved so far, and populists promising a guaranteed income are forming a coalition government with separatists demanding a flat rate income tax of only 15%. Much of the press is relating Italy’s economic woes to the Euro and some populist elements in Italy are playing with fire when toying with introducing a soft Lira. Brussels and Frankfurt will exert pressure on Rome making great headlines and sending the Euro and European markets occasionally lower.

 

How to make money in volatile markets

Where investing and waiting is a simple valid, profitable strategy in bull markets, volatility requires a more active and informed approach.

 

Some of the traditional instruments used in volatile times are gold and Volatility Futures. I am no fan of them. Commodities are not productive and investing in them is only driven by speculation, with gold having had a poor performance over the past five years. I find Volatility Futures hard to handle and it is tough to find the right entry point. I prefer shortening particular stocks and indexes when the signs are right. I also hold cash in orders to take advantage of extreme swings in stocks which I consider sound companies with a great future or sell positions in stocks where I see trouble ahead (eg Deutsche Bank or some UK retailers).

 

As a side note I would like to highlight the positive development of our unleveraged buy positions in eToro’s OutSmartNSDQ fund and GW Pharmaceuticals plc have developed well.

Sanctions, Trade Wars, Real Wars

Against all odds – sanctions, trade wars, real wars – the past week saw gains in the stock market, where we managed to recover some ground.

 

During stable periods, I am not a great fan of index trading, however with high volatility prevailing and some leverage applied, our trades in DAX30 / $GER30, CAC40 / $FRA40, IBEX35 / $ESP35 and Euro Stoxx 50 /  $EUSTX50 worked out well this week, producing profits for my eToro copiers. Despite our portfolio not profiting from this weeks’ recovery in crypto-currencies, we are benefiting from other shares gaining value again!

Fifth largest drop in the stock markets opens new opportunities

When markets hit record highs they turn jittery and corrections follow. This week we saw what some count as the fifth largest drop in stock market values ever. The portfolio has not been helped by a cooling of the interest in the ever expanding range of cryptocurrencies. More than 90 major cryptocurrencies quoted lower this week. For most cryptos, we may already be seeing a slow decline, reason why I decided to cut losses on NEO, XLM and BCH and may close Ethereum and Bitcoin soon:  http://iitm.be/cryptos4asset . I will also try to open more short positions in cryptos in addition to the short position on $BTC.

 

Because of market volatility I have been setting tighter stop losses on profitable positions, leading frequently to positions closing with small profits, followed by re-opening similar long positions at marginally lower prices. This has helped to lock-in profits from the likes of Aareal Bank AG / ARL, Aixtronic SE / AIXA, Alibaba Ltd / BABA, Davide Campari SPR / CPR, Cellectis SA / CLLS, Hella AG / HLLE, Leoni AG / LEO, Siltronic AG / WAF, Solvay SA / SOLB, as well as minor short trades in Paypal Inc / PYPL and and Petrofac / PFC.

 

A trade war?

Much of the steel dumped by China is generic and low grade. Despite some job losses in western steel mills, western consumers have been benefiting from cheaper steels and aluminium going into tins for food and drink and cheaper construction steel for factories, supermarkets and bridges. In turn much American produce and crops are sold overseas at lower prices than in their home market, thereby giving Chinese farmers cheaper pork and chicken feed and consumers cheaper food. Consumers throughout the world have been benefiting from increased competition through growing international trade. There is a chance that the American administration wants to direct their trade negotiation with the Chinese towards extracting greater respect for Intellectual and an opening of their market for Foreign Direct Investment. As far as the EU as the world’s largest consumer market is concerned it has much leeway in trade talks, I don’t expect the USA to start a trade war with the EU and our portfolio reflects that.

 

US stocks tend to have stretched price to earnings ratios. Our portfolio contains more EU shares than most on eToro. I expect the value our portfolio of shares in excellent and promising businesses to grow over the coming days and weeks, as pressure on the US administration increases to calm markets.

 

The market correction is probably worrying for the copy trader. However, if you share my optimism in the recovery of stocks like Santander SA / SAN, ThyssenKrupp AG / TKA, Unilever plc / ULVR, Inditex SA / ITX et al, then now is an optimal moment to copy my trades on eToro: http://iitm.be/oroetoro