By Hamish Preston
The last few days have been turbulent for financial markets as coronavirus contagion fears took hold. Global equities fell; the S&P 500's 6.6% price return plunge since the end of last week wiped off its year-to-date gains; recent U.S. sector and industry declines mean that nearly all S&P Composite 1500 industries are down month-to-date; and safe havens rallied - the 10-year U.S. Treasury yield hit an all-time low on Tuesday. Unsurprisingly, perhaps, VIX spiked earlier this week, closing above 25 for the first time in over a year on Monday.
Amid the recent turbulence, people may be tempted to turn their back on equities in favor of so-called safe havens. But while this strategy may help to mitigate losses in the short term, it is worth remembering that rotating out of equities has risks, too: the difficulty in timing the market means there is a danger of missing out on upside participation. This is especially relevant given the current dispersion-correlation environment suggests it is unlikely that we're on the cusp of a sustained bear market.
Exhibit 2 shows the average 1-month, 1-quarter, 6-month, and 1-year S&P 500 price return following various daily price returns for the U.S. large-cap equity benchmark, based on data over the last 50 years. The daily price returns (x-axis) were chosen such that 5% of daily moves fell into each "bucket". Quite clearly, the S&P 500 typically rose, with stronger price returns usually following larger market declines. For example, the subsequent returns for the leftmost bucket ranked as the first, second, second, and third highest across 1-month, 1-quarter, 6-month, and 1-year horizons, respectively.
Given the inherent difficulty in correctly anticipating market movements - for example, not many people predicted the S&P 500's record-setting start to 2019 following the turbulent Q4 2018 - using sectors to express views may provide a useful way to maintain asset allocations while dialing risk up or down within equities: sector rotation can be just as powerful in allowing market participants to express views.
And for those considering turning to active management under the belief that active managers are better able to navigate periods of market volatility, our Risk-Adjusted SPIVA Scorecard offers pause for thought. Most U.S. equity active managers underperformed their index benchmarks on a risk-adjusted basis over 5-, 10-, and 15-year horizons. In other words, there is little evidence to suggest that active managers are better at managing risks than their index benchmarks.
In conclusion, even though we will have to wait and see how the market works through coronavirus fears, market participants may wish to consider staying the course by maintaining exposure to equities via an indexed-based approach.
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.