Equity markets in August were notable for their volatile swings, especially
as it related to shifting sentiment on trade. The VIX volatility index reached a high of 24.59 on August 5th and closed out the month at 18.98. As reference, the highest point reached all year was on January 3rd, when it touched 25.45.
What was remarkable about last month however, was just how often seemingly unrelated areas of the market traded in the same direction.
According to data from Dow Jones, all eleven of the S&P 500's sectors either rose or fell together eleven times during August. As seen in the chart above, that was highest frequency rate since January 2016. But the analysts at Dow Jones looked beyond the S&P 500 and found oil prices, international equities and bond yields all traded in the same direction as US stocks seven times last month.
What does that tell us? When different types of investments move in the same direction, it actually contributes to volatility and could mean fewer places to "hide" if there is a sudden downturn. Uncertainty about tariffs and a prolonged trade war helped fuel the large market swings we saw in August. And with increasingly bitter rhetoric and major differences on several issues, neither China nor President Trump appear likely to
blink any time soon.
Furthermore, investors should consider how crowded trades could impact portfolios if the markets turn south. We've discussed a number of times how the FAANG 6 have dominated market returns in recent years. New data from Cliffwater shows the five year total return performance of the S&P 500 was 73%. But if you exclude Facebook, Apple, Amazon, Netflix, Google and Microsoft, the five year total return was -12%! With so many investors owning those few companies, if (when)
momentum flips, an unwinding of those positions can swiftly drag down markets. That is exactly what we experienced in December of last year.
What can investors do? The number one way to insulate yourself from the type of lockstep movements we saw in August, is to fully diversify your portfolio by including assets that are less likely to move in the same direction as traditional stocks and bonds. This includes alternative investments like hedged equity, real assets, direct lending, BDCs and high yield bonds. After that, it's important to remember that your portfolio's asset allocation has been structured for the
. Resist the urge to sell when markets turn south. Economies cycle through expansionary and recessionary periods, but your investment portfolio should be built to weather different environments so long as you are willing to look past short term fluctuations.
With trade uncertainty, a slowdown in global growth, low inflation, geopolitical risks, monetary policy changes, Brexit and a potentially rancorous US election campaign,
it looks as if volatility is here to stay. Having the right asset allocation and investment policy in place can help. If you're interested in learning how New Market Wealth is constructing resilient portfolios for today's environment, give us a call.