Beware the “Known-Unknowns”

by: , Chief Investment Officer and Managing Director | IndexIQ; Mark Lacuesta, FRM, CAIA, CIPM, Director of Index Strategies, IndexIQ

October reminded us that markets can be volatile, with the S&P 500 dropping -6.84%, its worst one-month drop since September 2011 (which posted a -7.03% loss). It’s important to note, however, that the circumstances in 2011 and 2018 are quite different. In 2011, there were contagion concerns of the European sovereign debt markets, the U.S. credit rating was downgraded, and the U.S. and global markets were in the doldrums struggling to recover market drawdowns and economic stagnation.

While the recent -6.84% drop may cause some concerns for investors, the S&P 500 is still in positive territory year-to-date at 3.01%, outpacing both the MSCI EAFE (-7.96% in October; -9.28% YTD) and the Barclays U.S. Aggregate (-0.79 in October; -2.38% YTD). Q3 advanced gross domestic product (GDP) figures were reported above survey (3.5% actual vs. 3.3% survey), the labor market continues to tighten at an even lower 3.7% unemployment rate, jobless claims are falling, and job openings are on the rise. Fed Chair Powell also commented near the start of the month that the labor market is not at a point of overheating because the rise in wages have been consistent with observed price inflation and labor productivity growth.

With the economy exhibiting these healthy signs, Powell also commented in early October that the Fed is trying to strike a balance to move toward neutral rate levels. This caused the 10-year yield to accelerate past 3.0%, touching a 52-week high of 3.23%, and for U.S. equity markets to close in negative territory to end the first week of the month, earning Powell the ire of the President.

The increase in volatility during October could be attributed to the impact of “known-unknowns” such as the evolving trade war with China, the speed of rising input costs, slowing capital expenditure spending, and Brexit negotiations becoming better understood. The anecdotal evidence would suggest that with rising volatility, correlations also increase.

In other asset classes, the U.S. Dollar continued to strengthen in October versus both developed and emerging market currencies. With the rise in the dollar, the prices of WTI and Brent oil have fallen by -10.84% and -8.76%, respectively. While it remains true that high yield credit spreads are still at historic lows, spreads have risen in October. With the last Fed Funds rate increase having occurred in September, the chance of a fourth rate increase exists at the December meeting.

The eight broad HRFX index strategies1 each performed negatively in October but managed to a lower down-capture to the S&P 500.2

Key Economic Data3

  • The U.S. Bureau of Economic Analysis (BEA) advanced third quarter 2018 GDP was 3.5%. Real GDP grew by 4.2% in the second quarter of 2018, 2.0% in the first quarter of 2018, and 2.9% in the fourth quarter of 2017.
  • Headline inflation (U.S. Consumer Price Index for All Urban Consumers seasonally adjusted (CPI-U SA)) was at 0.1%. Core inflation (CPI-Ex Food and Energy) came in at 0.1%. For the last 12 months, the CPI-U NSA was 2.3% and the CPI-Ex Food and Energy was 2.2%.
  • The U.S. Bureau of Labor Statistics (U.S. BLS) announced that non-farm payrolls changed by 134,000 compared to the prior change of 201,000. Private sector payroll employment changed 121,000 compared to 204,000 from the prior period. The unemployment rate is at 3.7%. The underemployment rate increased by .1% to 7.5%. The labor force participation rate remained unchanged at 62.7%.
  • The U.S. Department of Housing and Urban Development (HUD) and the U.S. Census Bureau jointly announced that sales of new single-family houses were down -5.5% to 553,000. Housing starts were down by -5.3% to 1,201K from 1,282. Building permits were down -0.6% to 1,241K. Existing home sales were down -3.4% to 5.15 million units.
  • The Conference Board Consumer Confidence IndexTM was 137.9.

1. The eight HFRX index strategies are Equity Hedge, Equity Market Neutral, Event Driven, Distressed, Merger Arb, Macro, Relative Value, and Convertible Arb.

2. Bloomberg, as of 10/31/18.

3. IndexIQ, FactSet, as of 10/31/18.

The information and opinions contained herein are for general information use only. New York Life Investments does not guarantee their accuracy or completeness, nor does New York Life Investments assume any liability for any loss that may result from the reliance by any person upon any such information or opinions. Such information and opinions are subject to change without notice and are not intended as an offer or solicitation with respect to the purchase or sales of any security or as personalized investment advice. There can be no guarantee that any projection, forecast, or opinion in these materials will be realized. Past performance is no guarantee of future results. It is not possible to invest directly in an index.

About Risk

All investments are subject to market risk, including possible loss of principal. Diversification cannot assure a profit or protect against loss in a declining market. Investors cannot invest directly in a benchmark.

Foreign securities can be subject to greater risks than U.S. investments, including currency fluctuations, less liquid trading markets, greater price volatility, political and economic instability, less publicly available information, and changes in tax or currency laws or monetary policy. These risks are likely to be greater for emerging markets than in developed markets.

Treasury Securities are backed by the full faith and credit of the United States government as to payment of principal and interest if held to maturity.

The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.

Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted performance benchmark for investment-grade or better fixed-rate debt issues, including government, corporate, asset-backed, and mortgage-backed securities, with maturities of at least one year.

Brent Crude is a major trading classification of sweet light crude oil that serves as a major benchmark price for purchases of oil worldwide.

credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.

The Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the U.S. economy that consumers are expressing through their activities of savings and spending.

The Consumer Confidence Survey® reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes and buying intentions, with data available by age, income, and region.

Consumer Price Index for All Urban Consumers (CPI-U) – A measure that examines the changes in the price of a basket of goods and services purchased by urban consumers.

Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds that involves the simultaneous purchase of convertible securities and the short sale of the same issuer’s common stock.

Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings.

Distressed securities are securities over companies or government entities that are experiencing financial or operational distress, default, or are under bankruptcy.

Down-side capture or down-market capture ratio is a statistical measure of an investment manager’s overall performance in down-markets. It is used to evaluate how well an investment manager performed relative to an index during periods when that index has dropped. The ratio is calculated by dividing the manager’s returns by the returns of the index during the down-market and multiplying that factor by 100.

Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.

Event Driven investing is designed to capture price movement generated by a significant pending corporate event, such as a merger, corporate restructuring, liquidation, bankruptcy, or reorganization.

Equity Hedge investing buys stocks that are undervalued and short sells stocks that are overvalued. This strategy may commonly employ variable exposure as well as the use of leverage.

Global Macro strategy is a strategy that bases its holdings, such as long and short positions in various equity, fixed-income, currency, commodities, and futures markets, primarily on the overall economic and political views of various countries, or their macroeconomic principles.

HFRI Hedge Fund of Funds Index – Fund of Funds invest with multiple managers through funds or managed accounts. The strategy designs a diversified portfolio of managers with the objective of significantly lowering the risk (volatility) of investing with an individual manager. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio.

MSCI EAFE Index consists of international stocks representing the developed world outside of North America.

MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure equity market performance in global emerging markets.

Relative-value arbitrage is an investment strategy that seeks to take advantage of price differentials between related financial instruments, such as stocks and bonds, by simultaneously buying and selling the different securities—thereby allowing investors to potentially profit from the “relative value” of the two securities.

The S&P 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The U.S. Consumer Price Index (CPI) is a set of consumer price indices calculated by the U.S. Bureau of Labor Statistics (BLS). To be precise, the BLS routinely computes many different CPIs that are used for different purposes. Each is a time series measure of the price of consumer goods and services.

The U.S. Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending.

yield curve is a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.

West Texas Intermediate (WTI) crude oil is the underlying commodity of the New York Mercantile Exchange’s oil futures contracts. Light, sweet crude oil is commonly referred to as “oil” in the Western world.

New York Life Investments is a service mark and name under which New York Life Investment Management LLC does business. New York Life Investments, an indirect subsidiary of New York Life Insurance Company, located at 51 Madison Avenue, New York, New York 10010, provides investment advisory products and services. IndexIQ® is an indirect wholly owned subsidiary of New York Life Investment Management Holdings LLC and serves as the advisor to the IndexIQ ETFs. ALPS Distributors, Inc. (ALPS) is the principal underwriter of the ETFs, and NYLIFE Distributors LLC is a distributor of the ETFs. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. ALPS Distributors, Inc. is not affiliated with NYLIFE Distributors LLC. NYLIFE Distributors LLC is a Member FINRA/SIPC.


Salvatore J. Bruno

Chief Investment Officer and Managing Director | IndexIQ

Sal is Chief Investment Officer at IndexIQ, where his primary responsibility includes developing and maintaining the firm’s investment strategies. Sal joined IndexIQ in 2007 from Deutsche Asset Management (DeAM) where he held a number of senior positions

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Mark Lacuesta, FRM, CAIA, CIPM

Director of Index Strategies, IndexIQ

Mark is Director of Index Strategies at IndexIQ where he is responsible for overseeing IndexIQ’s proprietary and third-party indexes underlying the firm’s ETF offerings. In this role, Mark is involved with research, product development, trading, sales, and marketing

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