In this month’s video, Investment Director, Ritu Vohora reflects on the return of volatility in 2018 and what it means for equities as we look ahead to the new year.
Despite a modest equity rebound in November, as we draw to the close of 2018, it’s on track to be a painful year for an unusually wide range of assets. There has been nowhere to hide year-to-date.
Even reliable safe havens such as gold, the Japanese yen and US Treasuries have not provided much relief. We have seen significant falls across global equities as well as stress in credit markets. In fact, 90% of the 70 asset classes tracked by Deutsche Bank were posting negative total returns, in dollar terms, through mid-November. There hasn’t been this much red for investors in nearly 100 years. The US dollar is one of the few areas in the black, year-to-date.
Whilst most equity markets rallied during November, they remain in negative territory year-to-date. Cyclical regions including Asia Pacific ex-Japan and emerging markets outperformed the global market, led by Turkey and Indonesia. However, emerging markets remain the worst performing region year to date, while the more defensive US leads. Brexit uncertainty continues to weigh on UK shares.
Commodities lagged in the month, with oil the worst performer, down more than 21% (in dollar terms) – its worst month in a decade. US crude has been battered by supply concerns, global politics and demand fears. As usual, OPEC’s decision on future levels of production will determine where prices head in the near term.
From a sector perspective, defensives drove November’s rebound – with healthcare, real estate and communication services leading the rally. Investors continued to have confidence in leading growth stocks for much of the year, until threats of tougher regulations and the failure of a few tech darlings to live up to lofty expectations, caused a dramatic rethinking of their valuations. Healthcare is now the best performing sector year-to-date, surpassing technology stocks, which gave up their earlier gains. Cyclical sectors – energy, technology hardware and materials – fared the worst in the month.
After an unusually tranquil 2017, we have seen the return of volatility in 2018. It’s been a banner season for largely negative superlatives, too – the largest monthly fall in crude in a decade, tech shares posting their worst day since 2011 and Bitcoin down more than 80% from last year’s high. Periods in which most asset classes decline in tandem are usually brief, but can be disconcerting.
There have been plenty of concerns for investors to grapple with, from growth topping out, to removal of central bank stimulus, trade tariffs impacting margins and derailing earnings, rising rates upsetting emerging markets and, more recently, weakness in US housing and autos.
Corrections can cause anxiety. But it’s important to keep things in perspective. The S&P 500 Index has seen four declines of 3% in 2018, more than in the prior three years combined. It has endured two corrections – declines of at least 10% from a recent high – largely due to the unwinding of crowded trades. The frequency of big moves relative to recent history has soared. But on a longer timeframe, they’re not particularly extreme.
Volatility experienced over the past few years has been subdued by historical standards – suppressed by easy monetary policies globally. The VIX volatility index, also known as the fear index, rises during periods of market stress. In 2017, it set record lows amid an ever-rising market. In fact, from January 1990 through December 2016, the VIX fell below 10 on only nine days in 27 years. But in 2017 it stayed below 10 for 52 days. The VIX was around 20 at the end of November. We’re now returning to a more normal volatility regime and should expect heightened volatility at this late stage of the cycle.
Some investors remain on edge, especially amid a flurry of predictions that the next recession is coming. But volatility is not the same as risk. The recent sell-off seems to be a bull market correction as markets adjust to a slower growth environment. The US economy is still healthy, albeit plateauing. And corporate profits are projected to grow solidly next year, even if it’s at a slower pace. Equities should continue to enjoy a modest leg up before the cycle ends.
It’s important to focus on long-term valuations of an asset class, rather than the volatility of its market price. Valuations on assets that were beaten up look more enticing today and provide a better risk-reward profile.
Global equities have de-rated meaningfully across all regions and are now below their long-term averages. Investors can still find attractive opportunities, but given the maturity of the current cycle, robust portfolio construction offers the best protection. Keep calm and stay invested.
The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.