The following is our perspective on the sudden return of volatility to the markets provided by David A. Klassen, Chief Investment Strategist.
What is happening in the markets?
It is October, and once again volatility has returned to U.S. equity markets, after a long period of exceptional stability and resilience. This prior resilience at home took place within the backdrop of negative performance in international developed indices in Europe and Japan, as well as emerging markets like China and Brazil. Now, U.S. stock markets have turned down rapidly.
What is the cause of this selloff?
The global economy started diverging in 2018, which means that countries and regions around the world stopped growing together like they did in 2017. Growth in the U.S. has been better, partly because growth here started earlier, but also because of shorter-term tax policies. The U.S. Federal Reserve has continued to raise rates, and market participants have now factored future rate increases into lower prices and higher yields. One additional negative factor is that U.S. companies have begun to admit they are feeling the impact of higher material prices brought on by increased tariffs.
What is likely to happen?
Although prices have declined, economic fundamentals are still positive, and earnings are still growing. The International Monetary Fund slightly reduced its growth forecasts, but a recession is not imminent. U.S. equities are now less extended, given strong earnings growth, and international stocks are becoming even more attractive. On the flip side, higher interest rates are a concern, as the 32-year bull market in bonds is likely behind us. Unsustainable deficit and entitlements in the U.S. may affect markets and negatively impact the dollar in the future. That could begin to swing the tide back to international investments.
The selloff will also likely create opportunities for some of the nimbler managers in the United Church Funds program. Volatility on the downside can quickly turn to volatility on the upside. At some point, bonds will become attractive again as yields rise.
How is United Church Funds reacting?
We reduced our equity exposure in the balanced funds over the summer, raised some cash and reduced our exposure to developed international managers to the point of being underweight that category while maintaining exposure to emerging markets. In fixed income, our positioning includes a healthy dose of floating-rate bank loans, which benefit from a rising interest rate environment.
International equities are attractive, and many of those economies are behind the U.S. in their recovery, with better earnings potential. We continue to favor diversification since that is the way to generate the returns necessary to cover most endowment draw rates. The possibility that international investments outperform U.S. investments over the next few years remains real, and many advisors, including Goldman Sachs Asset Management, urge staying the course.
We encourage you to contact us at [email protected] with any further questions you may have.