Be victorious over volatility

As economic cycles wind down, markets tend to exhibit greater volatility. With the current cycle being plenty long in the tooth—at 8.75 years old—some investors might be braced for the worst—especially after February’s downturn.

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When faced with volatility, Craig Jerusalim, a portfolio manager at CIBC Asset Management, keeps a cool head.

February’s volatility spooked some investors, but “that volatility is by no means a new normal,” he says. It also follows a predictable pattern.

Volatility “has been quite consistent with every single other drawdown that we’ve seen over the last hundred-plus years,” says Jerusalim. “Every time the market has a drawdown of between 10[%] and 20%, volatility spikes up.”

Read: Why client coaching can’t be left for corrections

Examples are market drops from the 1930s and 1950s. Those drawdowns came before the existence of hedge funds, quant funds and ETFs—“which are being blamed today for some of [the] volatility,” says Jerusalim. He describes volatility as “a normal course for the later stages of an economic cycle.”

That means the investing cliché holds: “More important is time spent in the market, as opposed to trying to time the market,” he says. Investors should instead focus on “what could be a longer-than-expected expansion.”

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Correction characteristics

When corrections occur, they generally consist of three stages.

In the first, “investors typically sell anything that has done really well or is liquid,” says Jerusalim. “That’s a tough environment for a quality GARP [growth at a reasonable price] manager like myself to be in, because typically the names of higher quality have done well.”

The second stage exhibits more relative trades. “Investors have time to parse out which companies are in better strategic positions to defend against an economic downturn,” he says. During “that part of the drawdown, a quality GARP manager can do quite well due to the focus on the business models of [companies].”

A broader, less strategic sell-off characterizes the third stage of a correction.

“Companies with the most levered balance sheets and the weakest business models are essentially sold out by investors on the fear that [the companies] could potentially go bankrupt,” says Jerusalim.

What this means, however, is “that’s the part of the drawdown where a quality GARP manager can significantly outperform.”

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Jerusalim says February’s volatility likely passed through only the first stage, and was largely a multiples correction, with earnings remaining robust. “Investors decided they weren’t willing to pay 18 times or 20 times forward earnings,” he says. “Instead, they were only willing to pay 15 times to 17 times forward earnings.”

“That’s why we saw price come down even though earnings continue to move up,” he adds.

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Confident investor conduct

Looking forward, “quality is where you want to be,” says Jerusalim. It’s important to “focus on companies that have the strongest balance sheets.”

Those are likely to be the ones that benefit from a positive business outlook based on strong synchronized global growth along with U.S. tax and regulatory reform.

Read: Why U.S. corporate earnings could boom in 2018

Further, “[interest] rates, which are rising but still accommodative, [are] another reason I would suggest to stay fully invested in the market today despite higher volatility,” says Jerusalim.

Rising volatility might spook investors and require extra communication on advisors’ parts, but Jerusalim suggests a good defence is to “buy companies with predictable, recurring, growing earnings. And avoid any balance sheet risk at all cost.”

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This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.