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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IMPORTANT INFORMATION: All investments involve risk, including loss of principal. Past performance is no guarantee of future results. An investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls. International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not  take into account the particular investment objectives, financial situation or needs of individual investors.

Diversification does not guarantee a profit or protect against loss.

Outperformance does not imply positive results.

Yields and dividends represent past performance and there is no guarantee they will continue to be paid.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.