What's really driving Market Volatility?

Equities have been falling since the start of October. While most equity markets have had a torrid time this year, US and Australian equities had a good year until the start of this month. The ASX/S&P 200 has fallen approximately 6.6% so far this year to 26 October, with the month-to-date fall almost 9%. The S&P 500, which was up almost 9% from the start of the year on 1 October, is now about flat for the year.

So what’s going on?

Like the sell-off in February this year, bond yields have been pushed to new highs for the year and have since pulled back as investors rushed to safe-havens. The difference is that investors are now less optimistic than in February and have a longer list of worries, from trade wars to slowing global growth. Even another strong reporting season in the US so far has failed to climb the wall of worry as investors have chosen to focus on slowing top-line growth or cautious guidance.

Unlike in February, when the market was indiscriminately selling off defensive and growth equities, the sell-off this time has been more concentrated in growth, while defensive sectors have outperformed, with utilities in the US being the best performer so far this month. This is suggestive that we are in a late-cycle environment, along with the uptick in volatility generally correlated to higher yields.

To sell or not to sell?

Being in a late-cycle environment does not mean that investors should sell everything and settle for low returns in cash. This stage of the economic cycle can last for long periods of time which can see equities continue to rally significantly. Market downturns without a recession also tend to end up being corrections or short-lived bear markets, with strong rebounds in short periods of time. Longer lasting and more painful bear markets usually coincide with a US recession. Why the US? Simply because it remains the largest and most influential economy in the world. As it stands, the US economy remains strong and a recession does not seem to be on the cards in the near-term.

Focus on the long-term

In this late cycle environment, investors should stick to their long-term investment strategy and not to get too caught up in the short-term moves as volatility begins to seep back into the market with higher yields. Research has shown that timing the market remains a fool’s game. Instead, we prefer to focus on valuations and be opportunistic through active security selection and tactical asset allocation, meaning that we will continue to tweak overall allocations rather than making wholesale changes to portfolios.

Earlier this year, we advocated for investors to position their portfolios more defensively and holding higher cash as we found less opportunities in equities. With the pullback and the strong profit growth, index valuations have now fallen below their long-term averages and we believe that it may be time to start selectively adding back to equities as they become cheaper.

If you have any queries or would like to speak with us regarding the above, please contact us or speak with your financial advisor directly.