Volatility Spikes as Trade Tensions Escalate
Sources: Sources for data in tables: Equity Market and Fixed Income returns are from JP Morgan as of 05/10/19. Rates and Economic Calendar Data from Bloomberg as of 05/10/19. International developed markets measured by the MSCI EAFE Index, emerging markets measured by the MSCI EM Index. Sector performance is measured using GICS methodology.
Global equities suffered significant declines last week as geopolitical events sent a number of major indexes to their worst weekly performance of 2019. In the U.S., the S&P 500 Index and the Dow Jones Industrial Average retreated 2.10% and 1.96% respectively. Companies of smaller capitalization were knocked down even further as the Russell 2000 Index returned -2.52% for the week. Overseas, developed markets lost 2.59% and emerging markets slid 4.51% last week. Consistent with the apparent “risk-off” sentiment, treasury yields declined as prices increased. The 10 year U.S. Treasury closed the week with a yield of 2.47%.
It’s no secret what led to the recent downturn. Some of the recent stock market rally has been attributed to market participant optimism that a trade deal between the U.S. and China would be reached in the near future. Despite some bouts of uncertainty, it was believed that the two sides were closing in on a deal. That came to a screeching halt last week when President Trump announced his plans to increase tariffs on $200 billion of Chinese goods. The news sent stocks south as uncertainty and doubt over an impending trade deal filled the air. To end the week, the U.S. officially made good on its previously mentioned announcement and raised tariffs from 10% to 25% and threatened additional tariffs on nearly all of China’s imports to the United States. The theme flowed into the current week as officials in Beijing announced retaliatory actions on $60 billion of U.S. goods and suggested they may stop purchases of agricultural products as well. Needless to say, this week was off to a rough start, particularly for those sectors that are believed to be most affected by trade with China.
Let’s take a look at one of the often cited indicators of stock market volatility. The CBOE Volatility Index, commonly known as the VIX, is recognized as the gauge of U.S. equity market volatility. Without getting too much into the weeds, the VIX is derived from measuring the implied volatility of S&P 500 Index options, and is used as a gauge for market risk and investor sentiment. In December 2018, within the midst of a dreadful fourth quarter in terms of stock market performance, the VIX reached a level of 36, the highest since February 2018. In 2019, the VIX has been as low as 11.03, representing an approximate drop of 70%, and the average closing price for the VIX in 2019 is 15.6 as of 5/10/19. Last week, however, escalating trade tensions caused volatility to re-enter the market sending the VIX higher, and, in particular, up over 30% on Tuesday alone.
We’ve said it before and we’ll reiterate it here again…we didn’t expect 2019 to be a smooth ride up. Investors certainly enjoyed the first quarter returns that many major indexes provided in excess of 10%. However, in the face of a slowing, yet growing, global economy and a number of potential headwinds, that pace was not sustainable. We are still bullish on additional stock market growth potential in 2019, supported by GDP growth, corporate earnings growth, and a confident consumer, to name a few reasons. Consider that for Q1 2019 (with 90% of the companies in the S&P 500 reporting), 76% of S&P 500 companies have reported a positive EPS surprise according to FactSet. In addition, we do expect a trade deal to get done. In fact, futures are already trading up on Tuesday as the U.S. and China have agreed to continue trade discussions. However, we expect continued short-term bouts of volatility throughout the year. As a result, we encourage investors to work with an experienced financial professional. Doing so could help prevent panic selling during bouts of volatility and the potential of missing out on future upside moves in the stock market. Financial professionals can help individual investors manage their portfolios based on their own unique objectives, time-frames and risk tolerances.
Investing in foreign securities presents certain risks not associated with domestic investments, such as currency fluctuation, political and economic instability, and different accounting standards. This may result in greater share price volatility. These risks are heightened in emerging markets.
There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.
The prices of small company and mid cap stocks are generally more volatile than large company stocks. They often involve higher risks because smaller companies may lack the management expertise, financial resources, product diversification and competitive strengths to endure adverse economic conditions.
Investing in commodities is not suitable for all investors. Exposure to the commodities markets may subject an investment to greater share price volatility than an investment in traditional equity or debt securities. Investments in commodities may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity.
Products that invest in commodities may employ more complex strategies which may expose investors to additional risks.
Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments may be worth less than original cost upon redemption or maturity. Bond Prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline of the value of your investment.
MSCI- EAFE: The Morgan Stanley Capital International Europe, Australasia and Far East Index, a free float-adjusted market capitalization index that is designed to measure developed-market equity performance, excluding the United States and Canada.
MSCI-Emerging Markets: The Morgan Stanley Capital International Emerging Market Index, is a free float-adjusted market capitalization index that is designed to measure the performance of global emerging markets of about 25 emerging economies.
Russell 3000: The Russell 3000 measures the performance of the 3000 largest US companies based on total market capitalization and represents about 98% of the investible US Equity market.
ML BOFA US Corp Mstr [Merill Lynch US Corporate Master]: The Merrill Lynch Corporate Master Market Index is a statistical composite tracking the performance of the entire US corporate bond market over time.
ML Muni Master [Merill Lynch US Corporate Master]: The Merrill Lynch Municipal Bond Master Index is a broad measure of the municipal fixed income market.
Investors cannot directly purchase any index.
LIBOR, London Interbank Offered Rate, is the rate of interest at which banks offer to lend money to one another in the wholesale money markets in London.
The Dow Jones Industrial Average is an unweighted index of 30 “blue-chip” industrial U.S. stocks.
The S&P Midcap 400 Index is a capitalization-weighted index measuring the performance of the mid-range sector of the U.S. stock market, and represents approximately 7% of the total market value of U.S. equities. Companies in the Index fall between S&P 500 Index and the S&P SmallCap 600 Index in size: between $1-4 billion.
DJ Equity REIT Index represents all publicly traded real estate investment trusts in the Dow Jones U.S. stock universe classified as Equity REITs according to the S&P Dow Jones Indices REIT Industry Classification Hierarchy. These companies are REITs that primarily own and operate income-producing real estate.