The domestic equity markets fell sharply in October amidst high volatility, with big swings day to day, and in some cases, intraday. After leading the way up over the last six months, the growth indices led the way down in the reversal, driven by steep losses in the largest technology names, such as Amazon and Netflix, both down roughly 20%. The pullback in the month appears to be a reassessment of risk and some of the lofty valuations reached by these technology companies.
Investors continuously look for an edge, seeking to maximize returns relative to risks. Favored strategies change cyclically, or trend during certain market environments, but one has always been in style: value investing. Value investors attempt to find underpriced stocks relative to fundamentals, and often examine valuation ratios or use a discounted cash flow model to uncover them.
October has stayed true to the historical trend of being the most volatile month for stocks, with choppiness creeping in, the equity market tanking, and the S&P 500 Index dropping by more than 3% last Wednesday, October 10. The sudden spike in the longer end of the curve beginning mid-September is one of the reasons cited for this huge sell off. The yield on the 10-year Treasury Note recently soared to a high of 3.23%, a level not reached since July 2011.
The domestic equity market continued to roll right along in August, driven by the Information Technology, Health Care, and Consumer Discretionary sectors. Given the much higher representation of these sectors in the growth indices, it is no surprise that growth outperformed value across the market cap spectrum. The Energy sector was the worst performer for the month, driven by the falling price of oil from its early August highs. This is the fourth consecutive month of positive returns for the large cap indices and the sixth consecutive month for the small cap indices.
Emerging markets stocks have declined significantly thus far in 2018, after a solid rally last year that led to the asset class’s best return since 2009. After reaching highs in late January, the space has slumped nearly 20%, stoking fears of further downside and potential contagion. The sharp pullback has caused many investors to question their commitment to emerging markets. Should they be worried, or is this pullback to be expected, given the historical volatility of the asset class?
Oh how the mighty have fallen…or have they? FAANG, an acronym that represents five of the most popularly traded Information Technology stocks, including Facebook, Apple, Amazon, Netflix, and Google (whose parent company is Alphabet), generally sets the tone of the domestic equity markets. Looking at attribution for large cap growth managers, over and underweights to these stocks in many cases have influenced the returns of their investment portfolios relative to their peers and benchmarks.
Domestic equity markets posted strong returns in the month of July, with most of the price appreciation coming in the first two weeks of trading. During the month, markets reached highs not seen since the end of January on news of strong economic data. The unemployment rate declined to 3.9%, the second lowest rate in the last 48 years, and second-quarter US Gross Domestic Product (GDP) grew 4.1%, the highest rate in almost four years.
Beginning in the second half of 2010, asset managers and economists began forecasting the Federal Reserve’s (the Fed) first postfinancial crisis rate hikes, and higher rates across the curve by the middle of 2011. It would be more than five years before the Fed’s first actual rate hike at the end of 2015, but for most of that period, the belief that higher rates were just around the corner convinced most asset managers to position their portfolios with shorter average maturities to minimize potential losses the higher rates would inflict.
Earlier this week, the International Monetary Fund (IMF) issued an updated World Economic Outlook, keeping its global forecast unchanged since April. It continued with an optimistic prediction that the world economy will grow 3.9% through 2019, but warns that expansion will be less synchronized, with risks tilted to the downside. 1 The IMF believes that near-term momentum in the US will continue, but is less optimistic about the eurozone, Japan, Latin America, and the U.K.