As of February 6, 2018
- U.S. stock markets experienced continued volatility this morning, trading within a range of nearly 1,000 points
- Yesterday, the Dow and the S&P experienced their largest one-day percentage decline since 2011
- The VIX spiked to its largest one-day percentage gain in history
- Prior to yesterday’s market close, we had not seen a one-day decline of 3% or more since the Brexit vote in June 2016
After a prolonged period of historically low volatility in the stock market, volatility returned in an historic fashion yesterday, pressuring the U.S. stock markets and bringing the record-setting upward pace of the market to a halt. The Dow Jones Industrial Average (Dow) experienced its largest one-day point drop, falling by 1,175 points. On a percentage basis, the Dow had a single-day loss of 4.6%. This was the largest one-day decline in the Dow since August 2011 and the first time since the Brexit vote in June 2016 that the Dow has seen a one-day decline of 3% or more.
The CBOE Volatility Index (VIX) spiked more than 100% yesterday to its highest level since 2015. The VIX is also referred to as the market’s “fear gauge” and is a barometer of market expectations of near-term volatility.
With the return of volatility, the year-to-date gains in the stock market have been erased. Why did this significant and sudden market decline occur?
Reason #1—Fears of Rising Inflation
Fundamentals are strong and other factors such as sustained low unemployment, improving corporate earnings, tax reform relief, and increasing individual purchasing power are contributing to a strong economy. That said, with strong economic data come fears that inflation will increase.
Reason #2—Fed May Accelerate Rate Increases
10-year U.S. Treasury yields hit their highest level in four years this past week, and the Fed acknowledged at their meeting that they are likely going to need to tighten monetary policy faster than they originally expected. The Fed is data-driven and a number of factors go into their decisions, including how global markets are operating. They have signaled that they are considering on raising rates at least three times in 2018.
Reason #3—Computerized Sell-Off
Programmatic trading was also partially to blame for the market’s sharp decline. Computer-driven selling in the past has accelerated declines. This is known as a “flash crash.” There is some indication that various triggers were hit yesterday as the market fell through various key levels.
Current Portfolio Positioning
Among U.S. equities, our Defensive Equity Strategy continues to be fully invested based on the output of our long- and short-term models. Within these models, sentiment is becoming more positive following the recent decline in the S&P 500 that has reduced excessive optimism. Due to the recent decline, our trend factors are beginning to be negatively impacted. Should our models show further deterioration and market volatility remain elevated, we will stand ready to adopt a defensive position.
Relative to our international equity exposure, our momentum factors have continued to favor emerging markets and the ongoing decline of the U.S. Dollar has caused currency factors to favor emerging market regions. This led us to recently implement a modest increase in emerging market equities.
We will continue to monitor the evolution of our models against the backdrop of this current market volatility. Within our equity exposure, we remain focused on higher quality, value-oriented stocks, exhibiting positive price momentum.
Within our fixed income portfolios, during the past week, we reduced our high-yield positions and we currently favor investment-grade exposure in our fixed income allocation due to short-term momentum and spread factors. We are targeting a duration range neutral to the benchmark in the government portion of the portfolios.
Industry experts noted this morning that the Monday crash in October 1987 was followed by a “Turnaround Tuesday.” While we don’t know where the market will close today, we do know that it’s during times like these when the value of active and tactical managers shines through. Unlike other managers who do not employ a tactical approach, at Meeder we have the ability to make adjustments to our portfolios based on what our models are indicating. We have been managing volatility and helping investors stay committed to their investment goals for nearly 45 years. We will continue to monitor market developments and provide you with timely updates in the days to come.