October Volatility Leads to Market Rotation

October Volatility Leads to Market Rotation

Why it's important to diversify equity exposure during volatile markets and the later stages of a market cycle.

Since October 1st, we have realized increasing volatility in US equity markets, with the VIX up 108.2% and S&P 500 down -8.8%.

One of the longest U.S. bull markets in history appears to be showing signs of fatigue as recent dynamics begin to resemble signs of the later stages of the market expansion. 

We believe the market has begun to reassess risk based upon:

  • Transition from quantitative easing to tightening in the US as the Federal Reserve continues its pace of rate rises
  • The lack of resolution between the US and China weighing on earnings expectations, especially in the Technology, Materials and Industrials sector.
  • Rising costs, via increased workforce wages and material/commodity input costs
  • Weakness in the housing and auto markets as sales of new homes in the US fell for the fourth straight month in a row in September.1

Despite these issues, the underlying economic fundamentals remain relatively strong and we continue to advocate for strategic equity exposure. However, the market is realizing a rotation in terms of style and sector as value, dividends and low volatility stocks have outperformed their growth counterparts which have seen the sharpest declines. This repricing of risk and return provides a reminder of the inherent fragility of a narrow, concentrated market.

U.S. Factor Performance

Total return index value October 1st – October 24th (%)

Source: Bloomberg, as of 10/24/18. Factor Performance sourced from MSCI USA Factor Indices.

 

U.S. Sector Performance

Total return index value October 1st – October 24th (%)

Source: Bloomberg, as of 10/24/18. Sector Performance reflective of S&P 500 Index GICS Sector Classification.

 

After a decade-long growth/momentum rally, investor portfolios have become overly reliant on consumer facing technology and growth-oriented stocks and under exposed to defensive, dividend paying and value-oriented stocks. These under-appreciated stocks have the potential to provide an important source of diversification especially during the later stages of the market cycle which is often accompanied by heightened volatility and more frequent market drawdowns.


1 Source: Commerce Department, Wall Street Journal.

 

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Diversification does not guarantee a profit or protect against loss.

Outperformance does not imply positive results.

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