Dealing with Market Uncertainty & Volatility

This year has been exceptionally volatile for equities around the world. Several external factors, including the Russia-Ukraine war, the abrupt shift in the Fed’s monetary policy stance, and soaring oil prices have played roles in unsettling the markets. Collectively, this has resulted in volatile trading activity, a drop in liquidity, and a more challenging environment for capital deployment.

Market volatility is expected to persist and it signals the need for preparedness from publicly traded companies, executives, and investor relations teams. During times like these, understanding factors influencing your share price, and the impact on a company's cost of capital is critical. Proactively finding ways to manage these elevated levels of uncertainty can be an opportunity for you to differentiate yourself from competitors both in and outside your industry.

Last month, we brought together Industry experts to discuss the factors currently impacting financial markets and their implications on a company’s performance.

Meet the panel

Paul Mastrodicasa is the Managing Director, Institutional Equity Trading, at RBC Capital Markets. He’s been at RBC for 17 years and traded most sectors in Canada for institutional clients over that period. Paul’s current focus is the energy and industrial sectors. 

Derek Spronck is the Senior Associate PM, Public Markets, at BCI (British Columbia Investment Management Corporation). Derek works on a Canadian large cap fund which is just under $4 billion in active equities. He spent just over a decade at RBC Capital Markets, working on sell-side research and focusing on the industrial sector as a research analyst.

Jamie Heard is currently the Manager of Capital Markets at Terminaline Oil Corporation - the largest natural gas company in Canada. The role encompasses capital strategy, investor relations, and business development. Prior to joining Tourmaline, Jamie held roles at the team analysts level at hedge funds, and has experience on the sell side. 

Understanding cost of capital and how factors such as beta influence it

One of the questions that comes up frequently during volatile times, centers around trying to better understand the different factors that affect the stock price. 

From Paul’s experience with frontline and liability trading, he shared what he’s been seeing in terms of the key factors that drive the stock in today's market. More specifically, what he saw in Q1 was unique relative to a more normalized trading environment.

“While I'm a firm believer that fundamentals will drive share prices over the long term, there's no doubt that in the short and medium term share prices are pushed around by multiple factors that are not stock specific.“

Over the years, Paul has seen the equity markets transition from the traditional single stock picking environment, to a complex web of cross asset, highly leveraged and highly quantitative investing styles that make explanations of day to day movements really challenging. 

Specific events with short term dislocation can be caused by:

• Quant revisions
• Expanding or decreasing gross exposures from hedge funds
• Margin calls
• Equity fund transitions which are occurring in increasing frequency 
• ETF activities which facilitate factor investing 

“All of these dislocations are going to be exacerbated by short term bouts of liquidity, like we saw in Q1. In Q1, we saw inflation's spike, yields rise, the invasion of Ukraine, among other things that led to a major trend change, and as a result, major longer term investment themes were challenged.”

Derek believes volatility is a way of life and something that we have to incorporate into our investment process. When the market gets volatile, the approach he takes to reevaluate positions in his portfolio is first to assess to see if there’s been a fundamental change, then to quantify it. From there, he can execute and adjust his portfolio accordingly.

Jamie shares that the majority of [Tourmaline’s] price movement internally is because the determinants of the company’s future cash flow are changing. Gas prices are going up & down, and commodity prices are changing opinions on inflation, for example. It's not an alarm that when the fundamentals change, the stock price changes. 

Understanding why that change is taking place can give you clues on how investors are thinking about your company, and you’ll need to address it with messaging. Specifically if you're outside of your peer group in the market, either on the up or down side, you need to understand and communicate with investors why that is.

Investor relations tactics to help minimize beta and share price volatility 

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Jamie touches on the IR tactics that his team uses to minimize beta and manage share price volatility during uncertain market environments. 

“Strategically, beta is primarily a factor of your operating leverage to your major cash flow inputs and your financial leverage. So when you're going into a period of market stress or sector stress, if you haven't been able to handle both of those variables, you're going to have higher volatility than your peers who have handled those things.”

From an IR perspective, helping investors understand some of the information that may not readily be available in most financial disclosures, such as your credit capacity and covenants, can be valuable information to include in your investment materials. 

Every crisis has its own recipe, but taking a prepared approach while communicating effectively is the fundamental of a key response. 

Communication approach for investors and shareholders as the market swings

Derek shares from the buy side perspective, the number one thing they want to understand when there's a market swing or increased volatility is what's causing it and then they want to quantify it. 

“The best IR teams will usually send out a quick email to investors. They'll be proactive. They'll be talking and communicating with the buy-side.”

As an IRO, having a really solid relationship with the market participants is critical. Building comfort level through regular dialogue and timely sharing of information can be invaluable to investors and management teams. Comfortable relationships can allow for real time feedback that can proactively help and address investor issues quickly. 

Understanding the different factors that move your share price 

The greater the volatility, the greater threat of potential investment outcomes there are, and the greater breadth of potential outcomes.

Derek shares, “When we see a stock that has higher volatility, we apply higher multiples to our valuation analysis or a higher discount rate to our DCF (Discounted Cash Flow) valuation. It essentially means that we require a higher rate of return on our investment to be compensated for that volatility.”

In general, when we think about the cost of capital, a lot of factors are out of your control. Sector risk can heavily influence your cost of capital, but there are ways to handle the risk that are in your control.

Jamie outlines a common theme across investors - if they don't have a strong grasp of what all the potential outcomes can be, they will pencil in some bad ones. 

“As an IR professional one of your jobs is making sure that you've got as many data points, and as much as you can. That helps the investor understand in different scenarios, what’s happened.  That’s providing sensitivity analysis, providing details about how your assets break down on a cost structure basis so your investors understand what your breakevens are. All these items are extremely important, because the investor is going to make assumptions.”

How to frame forward guidance and outlook commentary during periods of uncertainty 

Provide the tools that allow investors to build models and draw conclusions to minimize uncertainty. 

Annual guidance is important. If you don't provide guidance, or targets, you leave it up to the investors' devices to come up with different scenarios and potential outcomes. 

Make sure to provide all of the assumptions and color that you can so that the investor can do the analysis and they make those assessments on their end. 

To learn more, watch the full replay of this webinar here.