Mike Loewengart, Vice President of Investment Strategy
E*TRADE Capital Management
Investors may have felt a kinship with Olympic downhill skiers in early February—a big and fast drop at the top of the course and a hold-your-breath ride thereafter. Volatility eased somewhat and the market regained its edge by month-end, but it did not make it through all the gates unscathed.
Experts tossed around several theories about what caused stocks to correct (i.e., a decline of more than 10% from the recent peak). Consensus seemed to settle on inflation fears exacerbated by a strong jobs report, concerns that the Federal Reserve would raise interest rates more aggressively than forecast, Treasury yields rising, and expensive valuations. Traders betting that volatility would remain low likely had a say in the slide too. The Cboe Volatility Index® (VIX®) hit levels not seen since the financial crisis.
Many analysts chalked up the sell-off as healthy, in the “what goes up must (at some point) come down” sense. Perhaps making it easier to digest was the economy continuing to pick up speed. Count the Fed as positive on how it’s tracking. Among others, new Fed Chairman Jerome Powell highlighted a robust job market and accelerating wage growth as tailwinds in the semiannual monetary policy report to the House Financial Services Committee.1
The market seemed to think Powell’s testimony leaned hawkish. Stocks sold off and bonds slid as investors weighed whether he opened the door for a fourth interest rate hike this year, one more than previously forecast.2 And with that a capper on a topsy-turvy month, let’s take a look at what else had the market’s attention.
Without question, some of the swings in the major indexes were eye-popping. The Dow Jones Industrial Average lost 666 points, or 2.5%, on Friday, February 2. The following week was even rougher as the Dow lost 4.2% and 4.6% in two separate routs of more than 1,000 points.
However, stocks got back up and by the end of the month pared their losses, though not by enough to bring them back into positive territory. On a total return basis, the S&P 500® had its monthly winning streak snapped at a rather remarkable 15 months in a row, the longest in its history; the benchmark recorded its first down month since October 2016.
From a sector standpoint, there was really nowhere to hide. According to Morningstar Direct, Technology (+0.1%) was the only sector to post a positive total return, and even that was by the slimmest of margins. Notably, tech increased its weighting in the S&P to more than 25% in February, a milestone not seen since 2000. Financials (-2.78%) followed, perhaps buffeted by the prospects of banks benefitting from Fed interest rate action. On the other side, energy (-10.82%) struggled the most, likely pressured by falling oil prices, followed by consumer staples (-7.76%).
Foreign equities felt the pain too. All told, some estimated the sell-off across global markets at $6 trillion.3 But similar to stocks in the US, foreign equities eventually found some footing, likely backed by the still-intact global growth story. Foreign currency strength against a weaker dollar may have been a factor as well.
It wasn’t enough to erase all of the losses, but international’s attractiveness did not appear to wane, as fund flows remained strong. 4 For the month, emerging markets outperformed their developed market counterparts. By region, index provider MSCI’s EM Latin America and Europe, the Middle East, and Africa (EMEA) indexes, which captures large- and mid-cap representation across select EM countries, outperformed their counterparts in emerging Asia
In Asia, disappointing economic data and interest-rate talk seemed to weigh on the market at month-end. On the political front, investors found pros and cons with China’s plan to eliminate presidential term limits. The move would allow Xi Jinping to extend his term beyond 2023. Some analysts viewed such political stability as positive for Chinese assets. But they also noted the risk of policy missteps.5
The bond market fixated on the 10-year Treasury yield’s upward climb and its flirtation with 3%. While low historically, the market views 3% as an important psychological level—the 10-year is a benchmark that helps set the price for many (if not all) assets. The more attractive the yields are on safer assets, like government bonds, the less attractive investors may find equities.
At one point the 10-year yield went as high as 2.95% (and in the process wiped away a 300-point intraday surge in the Dow). For the month, it settled at 2.90%, up from 2.41% at the start of the year, but not before one last late jolt from Powell’s testimony.6
By segment, everything was negative. As would be expected in a rising rate environment, short-term Treasuries outperformed their longer-term counterparts. Treasuries with 1–3 year maturities (-0.04%) was the best performing area, followed by 3–5 year Treasuries (-0.26%). Treasuries with maturities 10 years and longer (-3.00%) performed the worst.
Source: US Department of the Treasury
The bottom line
It was never a question of if volatility would kick up again—it was when. Prior to February, the largest peak-to-trough decline in the S&P for nearly two years was a mere 3%.7 That’s not normal. What are normal are periodic pullbacks and corrections. And since they’re normal, they don’t have to be viewed solely in a negative light.
Rather than fearing downturns, investors may want to consider embracing the opportunities they present. As the stage appears set for volatility to change the scope of this bull market in 2018, now may be a good time to:
- Review risk tolerance. Regularly defining how much risk your portfolio can absorb can help keep market swings in perspective.
- Diversify. A broad mix of stocks including foreign equities and bonds, across the maturity spectrum, can help guide investors through volatility. The international story remains intact amid synchronized global growth, and the value offered by emerging market stocks may be worth a look.
- Rebalance. One way to cope with volatility is to rebalance back to target allocation. Disciplined rebalancing helps investors buy low and sell high by trimming winning asset classes and redeploying to those that have underperformed.
February was a case study in market turbulence—it can be a tough run out there at times. But even among the rough patches, investors can find opportunities that help keep their portfolios upright and on track to meet their goals.
As always, thank you for reading.
Vice President, Investment Strategy
E*TRADE Capital Management, LLC
Andrew Cohen, CFA
Director, Investment Strategy
E*TRADE Capital Management, LLC
Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) and Certified Investment Management Analyst (CIMA) designations. He is a graduate of Middlebury College with a degree in economics.
Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.
1. Monetary Policy Report, February 23, 2018, Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/monetarypolicy/files/20180223_mprfullreport.pdf
2. Smialek, Jeanna. “Here’s What We Learned From Powell’s First Fed Chair Testimony,” Bloomberg, 27 Feb. 2018. https://www.bloomberg.com/news/articles/2018-02-27/here-s-what-we-learned-from-powell-s-first-fed-chair-testimony
3. Leong, Richard. “Global growth outlook seen intact as stock market rebounds,” Reuters, 12 Feb. 2018. https://www.reuters.com/article/us-global-economy-goldman-sachs/global-growth-outlook-seen-intact-as-stock-market-rebounds-idUSKBN1FW1YD
4. Rennison, Joe. “US equity fund outflows continue despite rebound,” Financial Times, 23 Feb. 2018. https://www.ft.com/content/d446abf6-1827-11e8-9e9c-25c814761640
5. Lee, Justina. “What an Extension of Xi's Reign in China Means for Investors,” Bloomberg, 26 Feb. 2018. https://www.bloomberg.com/news/articles/2018-02-26/what-an-extension-of-xi-s-reign-in-china-means-for-investors
6. Franck, Thomas. “Yields jump after Fed Chair Powell hints at more than 3 hikes this year,” CNBC, 27 Feb. 2018. https://www.cnbc.com/2018/02/27/bonds-and-fixed-income-data-fed-speeches-on-the-agenda-for-investors.html
7. Guide to the Markets®, U.S. | 1Q 2018| As of December 31, 2017, page 12, JPMorgan Asset Management. https://am.jpmorgan.com/gi/getdoc/1383518167130