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?

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.

Disclosure:

Past performance does not guarantee future results.

The statements and opinions expressed in this article are those of the presenter(s). Any discussion of investments and investment strategies represents the presenter’s views as of the date created and are subject to change without notice. The opinions expressed are for general information only and are not intended to provide specific advice or recommendations for any individual. Any forecasts may not prove to be true. Economic predictions are based on estimates and are subject to change.

Investing involves risk, including the potential loss of principal. There is no guarantee that a particular investment strategy will be successful. Value investments are subject to the risk their intrinsic value may not be recognized by the broad market.

Definitions: American Depository Receipt (ADR) is a negotiable certificate issued by a U.S. bank representing a specified number of shares (or one share) in a foreign stock that is traded on a U.S. exchange. ADRs are denominated in U.S. dollars, with the underlying security held by a U.S. financial institution overseas. Correlation: is a statistical measure of how two securities move in relation to one another. A measure of 1 means the securities are highly correlated and move in conjunction. A measure of 0 means the securities are not at all correlated and do not move in conjunction. Dividend Yield: is a ratio that shows how much a company pays out in dividends each year relative to its share price. Standard Deviation is a measure of volatility of returns and is computed as the square root of the average squared deviation of the returns from the mean value of the return.

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