Joe Amato, Brad Tank and I all agree that “volatility is back, for good reason.” There is more than enough uncertainty around to justify the return of market jitters last week.
Nonetheless, there may also be growing certainty that the next 12 months are unlikely to bring a recession, even if they do bring a slowdown in economic activity. Historically, substantial corrections in equity markets have rarely gone on to become all-out bear markets absent a recession within 12 months. That is intuitive, and reminds us that we may soon be due a good, albeit volatile, market recovery.
A stronger hull certainly makes sense given the current choppy waters, but so does having the sails open for upside potential in the event of a strong recovery.
Caution is warranted. Alongside uncertainties that directly affect asset pricing—the path of rates in the U.S. and the pace of economic growth, particularly in China—there is still a lot of exogenous uncertainty around.
Last week alone, encouraging developments in the U.S.-China trade dispute were offset by Brexit confusion in the U.K. and hardening stances around Italy’s budget in the euro zone. Meanwhile, the U.S. is getting used to a divided Congress, the Bank of Japan is sending mixed signals, Germany is looking past the Angela Merkel era and Latin America’s three biggest economies are grappling with major political transitions.
This all contributes to volatility, and with stock-bond correlations rising there are few places to hide. Treasuries offered no shelter in October, or against the rise in volatility in February. As Deutsche Bank has observed, a higher proportion of asset classes have shown negative year-to-date U.S. dollar returns than in any year since records began.
Nonetheless, volatility is not the same as a sustained bear market.
At the end of October, the MSCI All Country World ex-USA Index was down 20% from its most recent peak. According to research from Goldman Sachs, when that has happened in the past, the subsequent 12 months have always resulted in positive returns, averaging 21.7%—as long as there wasn’t a recession during that time. When there was a recession, subsequent 12-month returns were almost always negative, to the tune of -11.4%, on average.
There was a near 10% correction to the S&P 500 Index in October. When that has happened in the past, the subsequent 12 months have generated a positive return eight times out of 10, and averaged 11.8%, in the absence of recession. With a recession, subsequent 12-month returns were flat on average.
An equity market correction against a background of an expanding economy has, more often than not, been a value opportunity. With that in mind, it’s notable that the combination of fast-growing U.S. corporate earnings and October’s selloff has resulted in the third-biggest calendar-year decline in price-to-earnings ratio since the 1970s.
Are we heading for a recession in the next 12 months?
The consensus in economic forecasts indicates that U.S. GDP growth will slow from a rate of 3.0% this year to 2.5% next year. Equity analysts expect S&P 500 earnings growth to slow from 25% to 10%. A slowdown is anticipated, but those are far from recession numbers.
Moreover, a little cooling in the U.S., together with the recent softness in oil prices, reduces the risk that U.S. growth and inflation further disconnect from the rest of the world’s, providing latitude for the Federal Reserve to raise rates more gradually than the “dots” currently forecast.
In our most recent Asset Allocation Committee Quarterly Update, I wrote that investors would likely have a clearer view on the robustness of the cycle by around the time of the U.S. midterm elections. We remain confident in a scenario of global stabilization and re-convergence for 2019, and therefore favor maintaining risk exposure in multi-asset portfolios—acknowledging that thoughtful and rigorous diversification is critical in such volatile and increasingly correlated markets.
In our view, it certainly makes sense to strengthen the hull with exposure to shorter-duration bonds and inflation-sensitive assets, but we also believe it makes sense to keep the sails open by being ready to add to U.S. and emerging markets equities upon continued market volatility.
Erik Knutzen, CFA, CAIA and Managing Director, is Co-Head of the Neuberger Berman Quantitative and Multi-Asset Class investment team and Multi-Asset Class Chief Investment Officer. Erik joined in 2014 and is responsible for leading the management of multi-asset portfolios, driving the asset allocation process on a firm-wide level, as well as engaging with clients on strategic partnerships and multi-asset class and quantitative solutions. To learn more, see Mr. Knutzen’s bio or visit www.nb.com.
In Case You Missed It
- Japan 3Q 2018 GDP (first estimate): +1.2% annualized rate
- U.S. Consumer Price Index: +0.3 in October month-over-month and +2.5% year-over-year (core CPI increased 0.2% month-over-month and 2.2% year-over-year)
- Euro Zone 3Q 2018 GDP (second estimate): +1.7% annualized rate
- U.S. Retail Sales: +0.8% in October
- Euro Zone Consumer Price Index: +0.2% in October month-over-month and +2.2% year-over-year
What to Watch For
- Monday, 11/19:
- NAHB Housing Market Index
- Tuesday, 11/20:
- U.S. Building Starts and Housing Permits
- Wednesday, 11/21:
- U.S. Durable Goods Orders
- Japan Consumer Price Index
- Friday, 11/23:
- U.S. Purchasing Managers’ Index
- Euro Zone Purchasing Managers’ Index
Statistics on the Current State of the Market – as of November 16, 2018
|S&P 500 Index||-1.5%||1.1%||4.1%|
|Russell 1000 Index||-1.5%||1.0%||3.7%|
|Russell 1000 Growth Index||-2.3%||-0.1%||6.5%|
|Russell 1000 Value Index||-0.8%||2.2%||0.7%|
|Russell 2000 Index||-1.4%||1.2%||0.5%|
|MSCI World Index||-1.4%||0.6%||-1.2%|
|MSCI EAFE Index||-1.4%||0.0%||-8.8%|
|MSCI Emerging Markets Index||1.0%||3.2%||-12.7%|
|STOXX Europe 600||-1.8%||-0.4%||-10.4%|
|FTSE 100 Index||-1.1%||-1.3%||-5.1%|
|CSI 300 Index||2.9%||3.3%||-17.4%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.3%||0.2%||0.6%|
|Citigroup 10-Year Treasury Index||1.0%||0.8%||-3.6%|
|Bloomberg Barclays Municipal Bond Index||0.4%||0.3%||-0.7%|
|Bloomberg Barclays US Aggregate Bond Index||0.5%||0.4%||-2.0%|
|Bloomberg Barclays Global Aggregate Index||0.4%||0.4%||-3.1%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.4%||-0.2%||3.6%|
|ICE BofA Merrill Lynch U.S. High Yield Index||-1.3%||-1.0%||-0.2%|
|ICE BofA Merrill Lynch Global High Yield Index||-1.2%||-0.7%||-2.0%|
|JP Morgan EMBI Global Diversified Index||-0.5%||-0.2%||-5.3%|
|JP Morgan GBI-EM Global Diversified Index||1.1%||2.6%||-7.6%|
|U.S. Dollar per British Pounds||-1.5%||0.5%||-5.1%|
|U.S. Dollar per Euro||0.4%||0.6%||-5.1%|
|U.S. Dollar per Japanese Yen||0.8%||0.0%||-0.2%|
|Real & Alternative Assets|
|Alerian MLP Index||-1.9%||0.9%||-1.7%|
|FTSE EPRA/NAREIT North America Index||0.0%||3.0%||3.0%|
|FTSE EPRA/NAREIT Global Index||0.3%||3.1%||-1.8%|
|Bloomberg Commodity Index||1.3%||1.0%||-3.2%|
|Gold (NYM $/ozt) Continuous Future||1.2%||0.7%||-6.6%|
|Crude Oil (NYM $/bbl) Continuous Future||-5.8%||-13.2%||-6.2%|
Source: FactSet, Neuberger Berman.