Volatility awakens in August

Mike Loewengart, Vice President of Investment Strategy

E*TRADE Capital Management

09/01/17

Volatility rose from its slumber in August. And investors appeared to move gingerly to avoid a rude awakening.

A host of uncertainties, ranging from domestic politics, to geopolitical tensions abroad, and the effects of Hurricane Harvey, weighed on domestic equities for most of the month. However, a late rally, perhaps helped by strong economic data, took the major U.S. indexes into positive territory. Recent market dips have been punctuated by swift recoveries,1 which likely speak to this long-term bull market’s resiliency. But the August tumult jolted Wall Street’s fear gauge. Sleepy for much of the year, the VIX® hit a 2017 high on August 11 amid heightened tensions between the U.S. and North Korea.

With volatility limbering up, it appears some active traders took risk off the table and looked for alternative sources of income and stability. For one, the Treasury yield curve, which plots interest rates for Treasuries against the length of time they have to reach maturity, flattened with growth and inflation still on the low side. A likely by-product of that flattening was a climb higher by the historically defensive utilities sector.

And for all the gold bugs out there, bullion rose 3.93% and hit its highest level of the year. Beyond the threat of international conflict, some may attribute gold’s rise to a Federal Reserve that is expected to ease up on its pace of interest hikes, which contributed to a weakening dollar.

The Fed was fairly quiet in August, despite its annual economic symposium in Jackson Hole, WY. No news may be good news, with observers expecting the Fed will continue to take slow steps towards normalizing monetary policy.

CBOE Volatility Index in August

Source: Chicago Board Options Exchange

Domestic equities

The S&P 500®, the Dow Jones Industrial Average, and the Nasdaq stood up to the uncertainty at home and abroad and ended August with slight gains.

U.S. equity performances in August

Source: Morningstar

Utilities’ bond-like characteristics found favor among investors during the month and came to life (+3.35%). Technology (+3.47%) and health care (+1.85%) followed. The energy sector (-5.18%) struggled once again, continuing a 2017 trend. Hurricane Harvey may likely continue to complicate matters for the sector, especially in energy-centric Texas.

International equities

Emerging market equities, likely benefiting from money funneling overseas and a soft dollar, remained a bright spot as investors continued to look for return potential in lands abroad.

International equity performances

Source: Morningstar

Latin America’s momentum continued with the MSCI LatAm Index up 4.62%, led by Brazil. Some market observers cited the Brazilian government’s announcement of privatizing a number of state assets as contributing to the MSCI Brazil Index’s August rise (+6.01%). The MSCI EM EMEA Index (+4.83%) and the MSCI EM Asia Index (+1.38%) notched positive gains as well.

Fixed income

Major fixed income asset classes were positive on the month, with high-yield corporate bonds the exception, likely due to increased risk aversion. Investors appeared to think long term with uncertainties on the rise.

Best and worst fixed income performances

Source: Morningstar

Treasury yields bounced around, ending moderately lower. The shortest maturities were roughly flat, however. The yield on the 10-year Treasury note ended August at 2.12%, versus end July at 2.30%.

Municipal bonds (+0.76%) performed about in line with investment-grade taxable bonds on the month, but they have significantly outperformed year to date (+5.20%). Despite continued hopes for lower individual tax rates as part of a broad tax reform, demand for munis has not waned.  

The bottom line

The case for diversification strengthens in the face of uncertainty. And in August, previously slumbering volatility had us going back to an asset allocation staple, Benjamin Graham’s The Intelligent Investor. One of Graham’s main strategies for asset allocation is good shuteye. Given no one can control the market, he suggests focusing on a strategy that’s not going to have you tossing and turning at night as the market ebbs and flows.

As a general framework, Graham recommends a 50/50 split between stocks and bonds when concerned about the market’s direction. If quite bullish, a 75% equity and 25% bond mix is appropriate; if overly bearish, 25% equity and 75% bonds. But it’s important to remember that asset allocation can be viewed as guard rails—they keep you in check, but still allow for movement across asset classes.

If looking to diversify in the current environment, investors may want to examine the following:

  • Within equities—international exposure through developed and emerging markets amid a positive global growth backdrop.
  • Within fixed income— despite a tough month, high-quality corporates in an effort to produce an incrementally higher yield over Treasuries; short-duration bonds to help offset concerns about rising rates; or Treasury inflation-protected securities (TIPS) before inflation ticks higher, as many market observers have long been predicting.

For many investors, a simple question to ask when market volatility creeps up is, how comfortable are you with risk currently, relative to your time horizon and goals? Seeking an answer to that question may help determine the right level of risk for you, how best to diversify, and how to find that good night’s sleep.

As always, thank you for reading.

 

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

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. El-Erian, Mohamed A. “Good Reasons to Dismiss Market Fears, For Now,” Bloomberg, 17 Aug. 2017. https://www.bloomberg.com/view/articles/2017-08-17/good-reasons-to-dismiss-market-fears-for-now