The third quarter was fairly benign on the surface, with the S&P 500 ending the quarter essentially flat. However, the stage was set for a market repricing from several key vectors. Small cap stocks weakened substantially, with the Russell 2000 losing almost 8% in the quarter. The strengthening dollar on the back of a weakening Europe led to concerns of forward earnings pressure for U.S. companies. Finally, the Federal Reserve tail wind has greatly diminished in the collective investor psychology as QE effectively ended on October 29, with an expected rate hike by mid-2015.
As our clients are well aware, we believe volatility creates opportunities. More than at any time since the crisis, we believe an investor’s “toolkit” should not be limited to equities and core bonds. Alternative assets, if implemented in a portfolio properly, have the ability to drive significant outperformance in this environment. Over the past several weeks, we had face-to-face meetings with over 20 specialized alternative asset managers to discuss the state of the world and where opportunities reside. Three primary take-aways from our meetings are:
Market stress, not systemic stress – While the sharp October pullback may have caused great disconcertment to many investors, we believe the probability of systemic stress is very low.
Fundamental and relative value opportunities – As markets “normalize” and correlation between single securities decreases, security selection can be a major source of excess returns (alpha), and opportunities reside in both the long and short side of the market.
Economic fundamentals still solid – We believe economic fundamentals continue to be solid in the U.S., albeit with subpar growth, with lower energy prices providing a healthy boost to consumer confidence and spending.