The elevated volatility and market losses that began in February 2018 continued through March, though the severity of losses in risky assets was not as severe as the month prior. While all major regional equity indexes depreciated, international-developed stocks fell less than most other regions, declining 1.7% in March (versus -4.5% in February). Comparatively, U.S. equities fell 2.5% in March (-3.7% in February) and emerging market stocks fell 1.8% (-3.9% in February). Large price swings throughout the month drove global equity volatility up and the VIX Index ended the month at 20.0 – still only slightly above its long-term, historical average. Throughout 2017, the VIX averaged 11.0 on a month-end basis reflecting one of the least volatile equity markets in market history.
January 1990 through March 2018
The decline in equites was largely driven by geopolitical factors and resulting uncertainty. President Trump announced on March 1st a tariff on steel and aluminum imports and tweeted the next day that “Trade wars are good, and easy to win.” This sparked fears in global stock markets that such a move would lead to retaliatory measures from other countries. After publicly stating his disagreement on the tariff matter, President Trump’s chief economic advisor, Gary Cohn, resigned. Later in the month, Trump proposed specific tariffs on Chinese imports. Trade war news caused the USD to be on the defensive most of the month and it ended the month declining 0.9% against G10 currencies.
Reacting to the sell-off in equities, fixed income assets generally appreciated during March. Thus, the asset class resumed its traditional role as a hedge to the performance of equities – a role that had been recently inconsistent. For instance, when global stocks fell 3.5% in February 2018, both global and U.S. investment grade bonds also depreciated in value by -0.9%. However in March, global investment grade appreciated 1.1% and U.S. investment grade gained 0.6%. The U.S. treasury 10Y yield ended the month at 2.74%, halting recent upward momentum. Following the direction of equities, U.S. high yield bonds also declined in value, dropping 0.6%.
Short Term Market Outlook
Our outlook on risky assets is cautious. Our tactical asset allocation models that forecast the relative performance between stocks and bonds are largely in neutral territory. One factor driving the decline in our global stock versus bond outlook is our leading economic indicator index, which is in slightly negative territory – a position itself driven by a decline in global trade prospects and a pullback in average hours worked. Also driving the neutral view between stocks and bonds is the interest rate trend. Despite the fact that the U.S. 10 year yield ended lower on a month-end to month-end basis, it has largely been trending upward throughout 2018. When interest rates appreciate, the cost of borrowing for both consumers and corporations increases. This has the effect of driving down spending and subsequent economic growth. The upward trend in interest rates has also made stocks less favorable from a relative valuation basis which also contributed to our moderate position between the two assets.
After several years of a persistently low equity volatility environment we expected that volatility would, eventually, return to historical “normal” levels. In hindsight, the market correction we saw in February and the subsequent elevated volatility seem like easy events to predict. So, the question on the minds’ of most investors, at the end of the first quarter, is likely “are recent market losses a sign of more to come, or simply a “hiccup” along the path of returning to the bull-market conditions of 2016 and 2017?”
We believe that when at these market crossroads, it’s helpful to go back to fundamentals. Most tellingly, global growth is pervasive. For the first time since the Global Financial Crisis, all of the world’s major economies exhibited year-over-year GDP growth. Furthermore, valuations, which had been a concern as we entered 2018, have pulled back following the recent market correction. Leading economic indicator indexes and the National Financial Conditions Index remain healthy and in looser-than-average territory.
We do have a concern about the speed at which interest rates rise. Generally, rising rates have a more adverse effect on stocks than bonds. This is because higher rates typically lead to more expensive credit conditions, thus discouraging borrowing and subsequent spending. Thus, while we aren’t quite ready to hit the panic button at this point in the market cycle, we are monitoring macro data with a very close eye.
This material is intended for informational purposes only and it is not intended that it be relied on to make any investment decision. It was prepared without regard to the specific objectives, financial situation or needs of any particular person who may receive it. It does not constitute investment advice or a recommendation or an offer or solicitation and is not the basis for any contract to purchase or sell any security or other instrument, or QS Investors, LLC to enter into or arrange any type of transaction as a consequence of any information contained herein. QS Investors, LLC does not give any warranty as to the accuracy, reliability or completeness of information which is contained in this document. Except insofar as liability under any statute cannot be excluded, no member of QS Investors, LLC, the Issuer or any officer, employee or associate of them accepts any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage whether direct, indirect, consequential or otherwise suffered by the recipient of this document or any other person.
The views expressed in this document constitute QS Investors’ judgment at the time of issue and are subject to change. The value of shares/units and their derived income may fall as well as rise. Past performance or any prediction or forecast is not indicative of future results. This document is only for professional investors. Investments are subject to risks, including possible loss of principal amount invested.
Global Equities represented by the MSCI ACWI Gross Total Return Local Index; Emerging Market Equities represented by the MSCI EM Gross Total Return Local Index; International Equities represented by the MSCI Daily TR Gross EAFE USD Index; U.S. Equities represented by the S&P 500 Total Return Index; Japanese Equities represented by the MSCI Daily TR Gross Japan Local Index; U.S. Dollar (USD)represented by the Bloomberg Dollar Spot Index; Global Fixed Income represented by the Bloomberg Barclays Global Agg Total Return Index Value Unhedged USD; U.S. Fixed Income represented by the Bloomberg Barclays U.S. Agg Total Return Index Value Unhedged USD; U.S. Treasuries represented by the Bloomberg Barclays U.S. Long Treasury USD
QSCR 18104 (April 2018)