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In Like A Lamb, Out Like A Lion: Volatility Returns In Q1

| April 17, 2018
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The market environment in 2017 was not normal. Volatility was abnormally subdued while risk appetite among investors soared to all-time highs. The S&P 500 broke records, including going more than 33 consecutive sessions without a 0.5% daily decline, going more than 244 consecutive sessions without a 3% drawdown and going more than 400 consecutive sessions without a 5% drawdown. While 2017 was a Goldilocks year of strong returns and record-setting low volatility, investors need to realize that 2017 was an outlier year and should prepare for a return of volatility to historical norms.

All of the low volatility records set in 2017 came to an end during the first quarter of 2018. Markets got off to a strong start with a near 7% advance for the S&P 500 in January. However, a return of volatility eroded all of those gains, pushing markets into the red as investors began to worry about the potential for an accelerated rise in interest rates and the potential for a full-blown trade war.

A combination of trade war concerns and a selloff in the technology sector led investors to flee U.S. equities.

Trade War Concerns

Trump has continued to apply pressure internationally through an array of tariffs. The president is also threatening to dismantle NAFTA, further fueling market uncertainty. China has since retaliated with its own set of tariffs. China imposed a 15% - 25% tariff on 128 U.S. goods, mostly focusing on agricultural products, such as beef, pork and almonds. China’s concentration of tariffs on U.S. agricultural products is an effort to hurt Trump’s core base of voters and put pressure on him to halt the implementation of additional tariffs. A breakthrough on a NAFTA deal could help shore up concerns of a deteriorating U.S. position in global trade; the Trump administration is pushing for a NAFTA deal in principle to be announced in April at the Summit of the Americas in Peru.

Tech Selloff

The FANG stocks – Facebook, Amazon, Netflix and Google – which have been the market leaders since 2015, have fueled the recent market selloff. While there were a number of company-specific headlines (Trump feuding with Amazon via tweets, Tesla auto crash fatality and inability to meet Model 3 production targets and Apple ditching Intel for in-house computer chips), the broader market implications stemmed from a combination of the longstanding outperformance of growth and momentum factors, the sector’s outsized weighting in the S&P 500.

Portfolio Shift

The Tompkins Investment Committee shifted from a sizable overweight in growth stocks to a slight overweight in value stocks in mid-February. This move lowered our exposure to the technology sector, which was a timely move given the recent weakness in tech, with technology mega-caps dragging down the performance of major indices.

Silver Lining

Improved valuations are a positive for the market. The S&P’s 500 latest decline has made it the cheapest since the global selloff that followed Brexit. Lower valuations combined with expectations of positive first-quarter earnings are likely to slow further declines.

Sinking Valuations
U.S. stocks haven't been this cheap since the post-Brexit drop.

Source:  Bloomberg

Closely Monitoring Market Technicals

The S&P 500’s recent close below its 200-day moving average was the first since Brexit in June 2016. We are closely monitoring market technicals and keeping an eye on a number of indicators.

Source:  Bloomberg

In the chart below, the market uptrend established in March 2009 is still within the one standard deviation channel line from the central regression line (red line.) We will be more concerned if the second standard deviation line (lower green line) is disrupted.

Source:  Bloomberg

Conclusion

Investors should prepare themselves for a return of volatility, especially after an abnormally quiet 2017. At Tompkins Financial Advisors, we focus on structuring diversified portfolios that protect against market volatility. We not only include stocks and bonds, but also alternative strategies that have low correlations to equities and fixed income. While bonds don’t offer foolproof protection in sell-off scenarios, due to their rising correlations during periods of market stress, alternative strategies can offer another avenue of portfolio diversification.

 

Disclosures

Investment products are not insured Tompkins Trust Company deposits and are not FDIC insured. These products are not obligations of Tompkins Trust Company and are not endorsed, recommended or guaranteed by Tompkins Trust Company or any government agency. The value of the investment may fluctuate, the return on the investment is not guaranteed, and loss of principal is possible.

No strategy assures success or protects against loss. Stock investing involves risk, including loss of principal.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. All economic data is historical and not indicative of future results.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Investments will fluctuate and when redeemed may be worth more or less than when originally invested. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.

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