Volatility came back in a big way during the first quarter. Wall Street’s fear gauge, the Cboe Volatility Index®, shot up more than 80% as Technology stocks struggled, fears about higher interest rates and inflation bubbled to the surface, and geopolitical uncertainty became pervasive.
For investors, volatility can be unsettling, especially when it hasn’t been around for a while. The historically low volatility year that was 2017 may have lulled some into a false sense of security. But when volatility does ramp up, it’s important to not lose sight of the fundamentals; and to remember that diversification, whether by asset class, geography, sector, themes, or factors, can be a friend.
Speaking of friends, this ongoing tariff spat between the US and China threw the market for a loop as Q1 came to a close and had it wondering where the relationship goes from here.
The market’s dilemma: Are we in a trade war or is this just bluster?
Some liken the escalating tariffs talk with China to a big game of chicken. If that’s true, someone may want to give the market a heads-up. Trade war rhetoric is rattling the market and taking trillions of market cap from investors.
The numbers don’t appear to add up to warrant picking a fight with China on trade. US exports to China are less than 1% of gross domestic product, the vast majority of which are agricultural products. It seems unlikely that this administration would want to hurt America’s farmers, especially ahead of the mid-term elections.
Perhaps this president feels like he has some wiggle room with the market to try to tilt global trade in America’s favor. It is true that S&P500 is still up by about 25.5% since election-day through 4/09/18. But markets (and voters) have short memories, particularly when the strategy appears to be less than clear.
No winners in a trade war
What is pretty clear is that no one is going to win in a trade war, particularly consumers. Tariffs are inflationary, plain and simple. And as inflation started showing signs of rising before the tariff barbs started to fly last month, the economy may have to contend with a compounded effect.
As indicators go, inflation is lagging. It’s also indicative of a late cycle market. At the end of a cycle, even an extremely elongated cycle, improved corporate profits usually means higher wages. When companies and households have more money, they’re deemed more creditworthy and lending increases. A byproduct is that inflation usually ticks up too.
What these tariff salvos do is add wrinkles to an already tricky market.
Market volatility as an opportunity: Is your portfolio positioned correctly?
Traditional market cap-weighted index investing has worked well for some time. But in our view, recent developments may make now a good time to look into alternative approaches, such as factor investing, for better risk-adjusted return potential.
The end of this economic cycle appears to be nigh. The Federal Reserve sounds more hawkish. Global central banks are removing their own stimulative policies. And volatility looks like it’s going to be the norm in 2018 amid potentially disruptive events such as a trade war.
Specific to a trade conflict, investors may want to increase their exposure to domestic-facing US stocks. If March was any indication, the small-cap, and domestically oriented, Russell 2000 outperformed the Russell 1000. Looking ahead, the tax cuts likely will contribute to what is expected to be a decent earnings season, and perhaps help stabilize stocks.
Q1 by the numbers
A record January for the S&P 500® quickly gave way to a 10% correction in early February, and its first negative month since October 2016. After rallying back 8% by early March, a 5% pullback for the index yielded an ultimately negative month (-2.54%) on a total return basis and the first negative quarter (-0.76%) since Q3 2015.
Growth stocks recorded their worst month in more than two years in March, but still beat Value by nearly 4%in Q1. The Russell 1000 Value Index (-1.8%) beat the Russell 1000 Growth Index (-2.7%) by nearly 1ppt in March. Small (Russell 2000) beat large (Russell 1000) for both the month and the quarter.
Information Technology, long a star of this bull market, was still the best-performing U.S. large cap sector in Q1 (+3.5%) despite its March sell-off taking 1ppt from the S&P 500’s return in March amid increased focus on data privacy and fears of new tariffs in China.
Consumer Discretionary (+3.1%) and Financials (-1.0%) followed Tech in Q1. Telecom (-7.5%) and Consumer Staples (-7.1%) brought up the rear.
Notably, returns for Real Estate and Utilities were strong in March amid a declining yield on the 10-year Treasury note. Conversely, Financials and Materials posted negative returns for the month.
Among asset classes including Treasuries, investment-grade corporate bonds, gold, and cash, S&P500 performed the worst in March. But they were in the middle of the pack for the quarter, beating both long-term Treasuries and investment-grade corporate bonds.
International equities struggled in March and Q1 as well, but outperformed US stocks.
All data sourced from Bloomberg
Category/Index Guide: Category (Name of Index) – US Stocks (S&P 500 Total Return Index), Russell 1000 Value (Russell 1000 Value Total Return Index), Russell 1000 Growth (Russell 1000 Growth Total Return Index), The Russell 2000 Index (Russell 2000 Total Return Index), Cash (Bloomberg Barclays US Treasury Bills 1-3 Months TR Index), Long-term Treasury Bonds (ICE US Treasury 7-10 Year Total Return Index), Investment Grade Corporate Bonds (Markit iBoxx USD Liquid Investment Grade Index), Non US-Equities (MSCI ACWI- Ex US Index), Gold (LMBA Gold Price PM USD Index)
(NYSE:CBOE) Volatility Index: Show the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options.
Russell 1000 Value Index: The index measures the performance of the large capitalization value sector of the U.S. equity market.
Russell 1000 Growth Index: The index measures the performance of the large capitalization growth sector of the U.S. equity market.
The Russell 2000 Index: A small-cap stock market index of the bottom 2,000 stocks in the Russell 3000 Index.
S&P 500 Total Return Index: The index includes 500 leading U.S. companies and captures approximately 80% coverage of available market capitalization.
Bloomberg Barclays US Treasury Bills 1-3 Months TR Index – Designed to measure the performance of U.S. Treasury bills maturing in 1 to 3 months.
ICE US Treasury 7-10 Year Total Return Index: Designed to measure the performance of U.S. Treasury bills maturing in 7-10 years.
Bloomberg West Texas Intermediate (NYSE:WTI) Cushing Crude Oil Spot Price Index: Designed to track the spot price of WTI.
Markit iBoxx USD Liquid Investment Grade Index: Designed to represent USD investment-grade corporate bonds.
MSCI ACWI ex USA Index: A market-capitalization-weighted index maintained by MSCI and designed to provide a broad measure of stock performance throughout the world, with the exception of U.S.-based companies. The MSCI ACWI Ex-USA includes both developed and emerging markets.
LMBA Gold Price PM USD Index: Designed to track the spot price of gold.
The Russell 3000 Index: A capitalization-weighted stock market index, maintained by FTSE Russell that seeks to be a benchmark of the entire U.S stock market. It measures the performance of the 3,000 largest publicly held companies incorporated in America as measured by total market capitalization.
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