A number of events, including Federal Reserve interest rate hikes and the European Central Bank discontinuing its asset-purchasing program, contributed to increased volatility and a market sell-off toward the end of 2018.
“These two mechanisms are, in essence, removing liquidity from the market,” said Peter Hardy, senior client portfolio manager of global value strategies at American Century Investments, in a Jan. 18 interview. “That is putting pressure on asset prices, and it came in the form, specifically in stocks, of a market sell-off.”
Hardy, whose team manages the Renaissance U.S. Equity Income Fund, noted that from Sept. 21 to Dec. 24, the S&P500 dropped more than 19%. “That’s the peak to trough of the sell-off. The Russell 1000 value benchmark, one of the value benchmarks we compare ourselves to, was off almost 18%.”
The S&P 500 has since recovered somewhat, posting gains of close to 8% so far this year.
Also contributing to Q4 2018 volatility were investor concerns about global growth due to the U.S.-China trade war, Hardy said. “So, less accommodative monetary policy, concerns about global growth and trade wars, coupled with bad earnings from some bellwether tech companies, and you’ve got a very aggressive sell-off.”
One factor that impacted securities during the sell-off was rates. In December, the Fed raised its key interest rate for the fourth time in 2018, to a range of 2.25% to 2.5%, but yields fell, explained Hardy. The 10-year U.S. Treasury yield dropped from a high of 3.23% on Oct. 4, 2018, to a low of 2.56% on Jan. 3, 2019, leading to a “divergence in the performance of securities that are interest-rate sensitive.”
Utilities and REITs, for instance, tend to have higher yields and are more interest-rate sensitive. But the sectors were down only 1.64% and 9%, respectively, from Sept. 20 to Dec. 26, 2018, said Hardy. “So those yield-oriented sectors got a little richer from a valuation perspective, and would appear less attractive.”
Meanwhile, banks felt the pressure from falling yields and earnings decreased across the board. As a result, “financial stocks underperformed the broad market, falling over 22%. So, as an active investor, the underperformance in banks would make them appear more attractive, and we would’ve gotten more constructive on them,” noted Hardy.
He added, “Consumer staples was another sector that benefited from this interest-rate mechanism, as they have higher yields and are perceived to have greater degrees of stability.”
Another factor that impacted securities during the sell-off was commodity prices, which fell during Q4.
“Brent crude oil prices fell from a high of $85 a barrel during the fourth quarter to a low of almost $50 a barrel,” said Hardy. “As such, energy was the worst-performing sector in the S&P 500 and the Russell 1000 value, having a -28% return during the period.”
As a result, energy companies that were down at the end of 2018 now offer opportunities. However, Hardy warned, these businesses tend to be more volatile in general. “We offset that risk by buying the best businesses, [and] the highest-quality names in the sector.”
Hardy added that even during volatility and a market sell-off, there are opportunities. The key is to look at individual stocks, instead of just sectors. “We’re typically buying companies while they’re cheap. That cheapness usually comes with risk. We’ve just assessed that risk prior to investing in the company.”
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