Market Outlook: A Multi-Asset View

Choppy Markets Ahead

The global economic expansion and equity bull market that followed the Global Financial Crisis (“GFC”) is well past the nine-year mark, making it the longest bull-run in US history. 

While economic fundamentals are still sound in the US, and bull markets rarely die of old age, there are important indicators of the frail nature of the current environment. Market volatility in October and November 2018 was a stark reminder of the risks involved in equity investing, a feature that had been all-but-obscured by the long bull-run.

We expect that the future will look quite different from the past nine-plus years of rising equity and bond markets amid low volatility. At this juncture, several key market indicators are currently at historically high or low levels, suggesting ample potential for mean reversion.

Despite the more recent correction, valuations in US equity markets continue to appear stretched and suggest low potential returns going forward, volatility in equity markets remains at historical lows and there is a wide dispersion between the narrow segments of the market that have led the rally (US, China, technology and growth/momentum stocks) and the rest of the market (international, defensive sectors and value stocks), which exhibit more attractive valuations.

Since March 2009, the US market generated over 400% cumulative returns, outpacing international equities by over 200%; growth has outperformed value in the US by over 100%; and five US stocks have contributed over 50% to S&P 500 Index returns, year-to-date.

In addition, market volatility is expected to increase as the Federal Reserve and central banks across the globe exit accommodative monetary policies, global growth continues to soften, and markets process idiosyncratic events such as Brexit, China-US trade tariffs and other.

All of these features will likely make for choppier markets ahead and a long overdue potential repricing of risk and return.

Repositioning for the Markets Ahead

While financial markets rarely adhere to the Gregorian calendar, the start of the New Year usually offers investors an opportunity to revise their views, rebalance and reposition their portfolios.

Market corrections (declines of 10% or more) typically occur once a year. Over the last 80 years we’ve had 12 recessions but over 43 greater-than-10% market corrections. While obscured during the most recent narrowly driven bull market, such sell-offs are a reminder of the value of diversification. How much more room for growth in equity markets is there really given current levels?

The secular shift in the relationship between stocks and bonds, coupled with a potential increase in volatility in equity markets, implies that investors may have to look beyond traditional portfolio construction approaches and traditional equity exposure. Many investors have begun looking beyond the traditional 60% stocks/40% bond portfolio -- both at the asset allocation level, via exposure to truly uncorrelated return sources within alternatives; and within the equity sleeve, making adjustments to address the increased beta and volatility associated with certain factor and sector exposures.

Diversification Beyond Stocks and Bonds

Stocks and bonds have historically realized a negative correlation. However, since the global financial crisis, correlations have gradually climbed, with both asset classes largely rising in tandem.

As volatility has started to ripple through markets, stocks and bonds have accrued losses simultaneously — diluting potential diversification benefits. This leaves investors to consider the portfolio implications as the long-term complementarity between these asset classes begins to fray. 

Rising Equity-Bond Correlations
S&P 500 Index vs Barclays U.S. Aggregate Bond Index

Source: Standard & Poor’s, Barclays Indices, eVestment.through [date].  Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

Market environments in which stocks and bonds are positively correlated, such as the 1970-1990 period, require investors to resort to alternative sources of portfolio diversification. Equity market neutral strategies offer this diversification benefit and the opportunity for gains regardless of market direction, making them a compelling option for investors seeking to capitalize on diversification.

Defensive Equity: Equity Exposure with a More Attractive Risk Profile

Amid a trending and narrowly driven market, such as the one experienced post-global financial crisis, many investors may find their portfolios have increased exposure to Growth/Momentum factors and underlying consumer-facing technology companies (housed within Consumer Discretionary, Telecommunication Services and Information Technology sectors).

Taking on unintended risks increase a portfolio’s vulnerability to pronounced drawdowns as trends reverse. Factors such as High Dividend and Minimum Volatility and sectors such as Utilities and Consumer Staples, which have lagged since the global financial crisis, have exhibited a significantly lower beta to the market and realized a lower standard deviation versus their cyclical counterparts.

Factors and Sector Risks, 2018 Year to Date

Source: Standard & Poor’s, eVestment and Bloomberg. Factors represented by equivalent MSCI factor Indices and Sectors represented by S&P 500 Index GICs, Level 1 Classification. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. Figures reflect period of Oct. 1 through October 31. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.   

An allocation to defensive equity strategies, providing exposure to stocks with lower price volatility, higher dividends and strong earnings/profitability, adds a differentiated return stream with potentially more attractive risk-adjusted returns than the broad equity market.

 

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Current Volatility, Long-Term Opportunity
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Choppy Markets Ahead
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Time to Get Defensive?
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A Shift Toward Cyclicals
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Focus on Growth

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Definitions

Beta measures the sensitivity of an investment to the movement of its benchmark.  A beta higher than 1.0 indicates the investment has been more volatile than the benchmark and a beta of less than 1.0 indicates that the investment has been less volatile than the benchmark.

The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged index that measures the performance of the investment grade universe of bonds issued in the United States. The index includes institutionally traded U.S. Treasury, government sponsored, mortgage and corporate securities.

"Brexit" is a shorthand term referring to the UK vote to exit the European Union.

Correlation is a statistical measure of the relationship between two sets of data. When asset prices move together, they are described as positively correlated; when they move opposite to each other, the correlation is described as negative or inverse. If price movements have no relationship to each other, they are described as uncorrelated.

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The S&P 500 Index is an unmanaged index of 500 stocks that is generally representative of the performance of larger companies in the U.S.


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Derivatives, such as options and futures, can be illiquid, may disproportionately increase losses and have a potentially large impact on Fund performance.

Diversification and asset allocation strategies do not assure a profit or protect against market loss.

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

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