Volatility is Volatile

by: , Portfolio Strategist, New York Life Investment Management

Financial markets have fluctuated wildly this year, falling when fears of escalating trade tensions or slowing global growth dominate and rising when markets expect monetary or fiscal support.  Meanwhile, liquidity has tightened in some markets, prompting sharper price movements as volatility occurs. The S&P 500 has seen a rising number of days with movements of 1% or greater of late, which is naturally concerning for investors.

S&P 500 Price Action

Source: New York Life Investments Multi Asset Solutions team, Standard & Poor’s, Thomson Reuters DataStream. As of 6/11/19. Past performance is no guarantee of future results. An investment cannot be made directly in an index.

Market participants currently price in a riskier environment even as equities move higher. The CBOE Volatility Index (VIX), otherwise known as the “fear gauge,” currently trades above 15 – the level widely recognized as the difference between low volatility and elevated volatility – suggesting that expectations for future instability also remain elevated. There are several drivers of higher volatility, including:

  • Slowing economic growth: Global demand has slowed, which weighed on imports/exports and the manufacturing sector globally. Export-dominant countries like China and Germany have taken the brunt of this slowdown. Countries with trade deficits, on the other hand – like the United States – see less of an impact. Slowing growth means slower corporate revenue and profit growth.
  • Disruptive trade negotiations: Renewed trade tensions aren’t going away anytime soon as neither country looks eager to concede. For Trump, a tough on China stance is bi-partisan and politically popular. Meanwhile Xi and China appear adamant to maintain their terms of trade. The latest increase in tariffs is disruptive to the US and global economies. The tariffs impact economic growth, disrupt supply chains, increase currency volatility, and reduce business confidence.
  • Financial conditions: Central banks recognize these risks. Over the past several months, the Federal Reserve shifted to a significantly more accommodative posture ending balance sheet run-off, pausing interest rate hikes, and shifting its language to favor market support

Renewed trade tensions between the U.S. and China came at a bad time for market volatility, given slowing economic growth. The main risk is that contagion from the current trade war spreads to the broader economy. On the flip side, an optimistic outcome lurks if trade tensions dissipate. Interest rates are low, central banks are accommodative, and fiscal stimulus across Europe, the U.S., and China is supportive of growth.

Something to consider

While economic growth is slowing, it is still growing, and we do not expect a recession within the next 12 months. Our base case remains that a worst-case scenario will be avoided, and that a trade deal will be reached before the incremental tariffs have a strong impact on the economy. That said, given the length of the economic expansion, rising risks, and lower liquidity, the market may behave more erratically, feeding elevated volatility.

There are clear alpha-generating opportunities in volatility that add diversification to investors’ portfolios. This is true across equity, fixed income, and other asset classes, where investors can take advantage of natural inefficiencies in markets. We are neutral equities in our asset allocation portfolio pending greater clarity on trade negotiations or renewed signals of a rebound in global economic growth.

Past performance is no guarantee of future results, which will vary. All investments are subject to market risk and will fluctuate in value.

This material represents an assessment of the market environment as at a specific date; is subject to change; and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any issuer or security in particular.

The strategies discussed are strictly for illustrative and educational purposes and are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any strategies discussed will be effective.

Definitions

The S&P 500 Index is widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and captures approximately 80% coverage of available market capitalization.

The CBOE Volatility Index, or VIX, is a real-time market index that represents the market’s expectation of 30-day forward-looking volatility. Derived from the price inputs of the S&P 500 index options, it provides a measure of market risk and investors’ sentiments.

This material contains general information only and does not take into account an individual’s financial circumstances. This information should not be relied upon as a primary basis for an investment decision. Rather, an assessment should be made as to whether the information is appropriate in individual circumstances and consideration should be given to talking to a financial advisor before making an investment decision.

“New York Life Investments” is both a service mark, and the common trade name, of the investment advisors affiliated with New York Life Insurance Company. NYLIFE Distributors LLC is located at 30 Hudson Street, Jersey City, NJ 07302. NYLIFE Distributors LLC is a Member FINRA/SIPC.

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Robert Serenbetz

Portfolio Strategist, New York Life Investment Management

Robert Serenbetz is the Portfolio Strategist with New York Life Investment Management’s Multi Asset Solutions (MAS) team. He contributes to investment thought leadership and communication efforts across New York Life Investment Management

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