20th January 2016
Russ Koesterich, BlackRock’s global chief investment strategist looks at where investors can seek refuge from the global market sell-off…
Stocks continued to plummet last week. The Dow Jones Industrial Average lost 2.19% to close the week at 15,988, while the S&P 500 Index declined 2.18% to 1,880, and the Nasdaq Composite Index fell 3.34% to 4,488. In fixed income, the yield on the benchmark 10-year U.S. Treasury fell from 2.11% to 2.03% as its price rose.
Markets are still struggling with falling earnings and deteriorating conditions in credit markets, although there was at least some stabilization in China’s currency. But the losses were widespread — and brutal. U.S. small caps have now entered a bear market; biotech, a popular momentum trade, is down more than 30% from last summer’s high; and stocks in China have suffered a mini bear market, down 20% in just two weeks. A rally in U.S. shares on Thursday offered some relief, but stocks were unable to hold onto their gains and suffered heavy losses on Friday.
Not surprisingly, investors are now wondering what to do next. Understandably, many are seeking the comfort of so-called “safe havens” like long-term Treasuries. When it comes to stocks, higher volatility will likely continue, which leads us to favor themes such as quality (i.e., companies with less volatile earnings and little debt), as well as strategies designed to minimize volatility.
This time, the epicentre was the US
Unlike the previous week, China was not the clear catalyst for last week’s selloff. While Chinese equities remain volatile, both the currency and economic data were more encouraging. Moreover, the People’s Bank of China was aggressively buying the Chinese renminbi in the offshore market on Tuesday, which helped stabilize the currency and collapsed the spread between the onshore and offshore currency markets, a worrisome development during the first week of the year. On the economic front, both Chinese exports and consumer prices showed signs of improvement.
Instead, two other factors drove the decline. First, earnings estimates continue to drop. In the United States, fourth-quarter earnings for S&P 500 companies are expected to fall more than 5%, versus expectations of a 0.6% decline at the start of the quarter. This would be the first time since 2009 that earnings have contracted for three consecutive quarters. Although energy companies have been a big drag on earnings, every sector has seen negative revisions since the end of the third quarter.
In addition, the selloff in equities is coinciding with more signs of stress in credit markets. Last week, Standard & Poor’s noted that three times as many companies are at risk of a downgrade versus an upgrade, the highest ratio since 2009. While much of the deterioration is focused in energy and mining companies, both of which are struggling with collapsing commodities prices, the fear is that the damage will spread beyond natural resource companies.
Where to hide
Not surprisingly, with most risky assets under pressure and volatility at its highest level since last September, investors continue to flock to the safety of government bonds. Ten-year U.S. Treasury yields touched 2% last week, the lowest level since mid-October. German and Japanese 10-year yields are even lower, at 0.54% and 0.20%, respectively.
Short-term interest rates are also retreating, leading to gains in the short end of the yield curve. This trend accelerated on Friday following yet another weak retail sales number. With global growth in question, volatility rising and U.S. consumption erratic, the odds of a March interest rate hike by the Federal Reserve are dropping, from 50% in late December to 27% today.
For investors willing to maintain equity exposure, we would emphasize strategies such as minimum volatility, which, as the name implies, is explicitly designed to mitigate the impact of market gyrations. This approach is likely to prove more effective in an environment in which volatility is rising as a function of concerns over global growth, as opposed to other factors, such as rising rates. In addition, investors should look to stocks with high return-on-equity, low leverage and earnings consistency, often referred to as a quality theme. In a world in which conviction is plummeting, the market is likely to place a premium on consistency.