Uncertainty Drives Volatility
Uncertainty Drives Volatility
Market volatility reared its ugly head this fall, following a relatively quiet spring and summer. The S&P 500 has moved more than 1% on 25 trading days so far this quarter, compared to zero moves of such magnitude last quarter. Most of these moves have been on the downside, as the S&P 500 has fallen 15% since the end of September, erasing all gains that the index had seen up to that point, and bringing the year-to-date decline to 6%.
So what has caused such a dramatic swing downward? In one word: Uncertainty. Markets hate uncertainty, and there is plenty of it in the headlines. Between the trade conflict with China, the breakdown in Brexit negotiations, the Mueller investigation, oil prices in freefall, shrinking global growth forecasts, and a potential government shutdown, there is plenty for investors to worry about.
Furthermore, following the Federal Reserve’s widely-expected rate hike this week, investors are reading into chairman Jerome Powell’s comments that the Fed will continue its current pace of unwinding its balance sheet. This means that the Fed will not be buying bonds to replace maturing bonds purchased as part of the Quantitative Easing stimulus effort. The Fed did reduce the number of planned rate hikes next year from three to two. Powell also maintained that they will remain “data dependent,” signifying that they will react accordingly if there are signs of a slowing economy. However, underlying economic data indicates a robust labor market with low unemployment and rising wages. The fiscal stimulus provided by the tax cut spurred corporate earnings growth of 20% in 2018. The Fed anticipates inflationary pressures from the tight labor market, which is why it decided this meeting not to take a dramatic pause in its rate hike program.
We maintain our belief that the next recession will be caused by the Fed overtightening, or raising rates to a point where economic growth is impacted. However, we do not believe we are at that point now, given a still low 2.5% benchmark rate and the measured, cautious approach the Fed demonstrated at its last meeting. As long as uncertainty remains, there will be volatility in the market.
We remain fully invested at this time, but we have begun to pivot toward defensive stocks that should fare better in the upcoming economic environment. These include companies whose revenues are less dependent on robust macroeconomic growth as well as value stocks that have low valuations and high dividend yields. We are also adding short duration fixed income and money market funds to client portfolios where appropriate.
Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.