Higher sharemarket volatility set to persist after a year of market turmoil.
By most measures, 2020 was one of the most volatile years in sharemarket history. Investors were blindsided at the start of the year by a ‘once-in-a-century pandemic of global magnitude and hitherto unseen economic consequence.
This year is off on a roaring start in terms of shifting investor sentiment, with the repricing of inflation and the rotation to value trade, front of mind for investors.
While 2021 looks to be calmer than 2020, volatility will remain as the world continues a path to recovery.
(Editor’s note: learn about the features, benefits, and risks of warrants at Investing in Warrants on the ASX website.)
In this environment, investors looking at warrants as part of their portfolio should consider these trends:
1. Use Index MINIs to benefit in rising or falling, volatile markets
(Editor’s note: MINIs are open-ended warrants with no expiry date, offering leveraged exposure to either rising or falling markets. MINIs are available over a wide range of shares, indices, currencies and commodities, among other securities).
In late February 2020, as coronavirus accelerated, global equity markets plunged at a record-breaking pace. Indiscriminate selling characterised the mid-March 2020 period, with equities being described by some as “bidless” and traditional safe-haven assets such as gold and treasuries offering little refuge as a fear-induced flight to cash unfolded.
From a high on the 20th of February, the ASX200 plunged 36.5% in just 32 days.
Option and warrants markets were highly active during this period of turmoil. Daily warrant turnover in April reached the highest levels since 2014 on the ASX.
In Australia, market volatility saw ASX 200 Index MINIs take out eight of the top 10 most actively traded warrants in terms of volume (see table below).
MINIs are the most popular style of warrant traded in terms of value and enable investors to trade with a view of a share or market going up or down, with leverage.
Index MINIs were even more popular in 2020 as they enable investors to take a broad directional view of the market.
Not surprisingly, ASX MINI shorts took out 2nd and 3rd spot for most actively traded warrants. This is because they are a tool for investors and traders to hedge their portfolio.
If an investor has an equities portfolio and is anticipating a market fall, instead of selling out their share portfolio and triggering a capital gains tax event, they may simply put on a “hedge” (to protect their portfolio in a falling market).
As we expect volatility to continue, we anticipate these warrants will maintain their popularity through 2021.
2. US outperformance drives usage of NASDAQ MINI Longs
During the equity market recovery, the momentum trade was a top outperformer amid ample liquidity, low yields, and an acceleration in pre-existing technological and economic trends toward e-commerce and online consumption.
Information technology stocks and the tech-heavy NASDAQ index rallied sharply last year.
Financials and energy stocks were some of the hardest hit by the pandemic and this was one of the biggest reasons why the S&P/ASX 200 index (-1.5% in 2020) underperformed US equity markets during the recovery in the second half of the year.
With the outperformance of the US markets, NASDAQ MINI Longs were in the top 10 most actively traded warrants in 2020.
As vaccine optimism and fiscal support stoked a strong bid throughout the remainder of the year, concerns emerged over the possibility of stretched valuations and equity market exuberance.
Citi’s Global Strategy Team noted in January 2021 that while by some measures, markets are looking increasingly frothy; but current performance and valuations still lag previous “mega-bubbles” such as technology stocks in 2000.
These conditions, combined with low cash rates and an increasingly positive dividend outlook for sectors like resources and banking, mean both equities and warrants are likely to remain popular through 2021.
3. Choose sector-based warrant strategies to tap into the global recovery
A big-ticket item for Australian investors in 2020 has been the recovery in resources names, driven by higher iron-ore and commodities prices.
On the back of a faster-than-expected recovery in Chinese and global steel production, Australian iron ore prices increased 73% in 2020, driving the Australian dollar higher and underpinning the broader reflation trade (as the global economy recovers).
Citi’s metals and mining analysts believe that iron prices are well supported for now, with a tight market through the first half of the year expected.
Industry heavyweight Fortescue Metals Group (ASX: FMG) delivered stellar returns in 2020 and had the most actively traded warrants by value on the ASX. FMG MINI Shorts were traded as investors looked to hedge their position.
Staying positive as we return to pre-pandemic growth
Citi’s local economists have recently upgraded Australia’s average 2021 GDP forecast to 4.4%, implying a return to pre-pandemic levels in the first quarter (for economic growth) and a lower unemployment rate.
Investors can use warrants to take advantage of this growing optimism while sheltering their portfolio from market volatility.