Could this be the start of a new bear market?
After a two-month period in which the U.S. stock market reached new all-time highs, volatility has returned with a
vengeance. The Dow Jones Industrial Average (Dow) experienced a two-day decline totaling more than 1,300 points or
5.6%. The S&P 500 Index declined by 5.3% over the two days, which was its worst two-day decline since February, but is
down only 5.5% from its all-time high on September 20th.
The speed and sharpness of the decline and the volatility was reminiscent to what we experienced in February of this year. The CBOE Volatility Index (VIX) more than doubled yesterday to its highest level since February 12th. 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 recent market downturn, much of the gains in the stock market over the past few months have been erased. While
fundamentals are strong and leading economic indicators point to continued growth, there are headwinds that have been
impacting the markets and are factors in the recent market decline.
Cracks in the Foundation
Strong breadth has been a hallmark of the stock market’s advance over the last couple years. Essentially, this means
that we have experienced broad individual stock participation in the market’s gains, as opposed to the market being driven
by a handful of names or a specific sector. However, from late August through the S&P 500 peak on September 20th, we
did see signs that participation was narrowing despite the market’s continued advance. While this negative divergence is
not as pronounced as seen during previous major market tops, it is a factor we will continue to monitor.
Rising Interest Rates
The Federal Reserve raised the federal funds rate at the end of September by 0.25%. This brought the target for the
overnight lending rate between banks up to 2.25%. This is now the eighth time the Fed has increased rates since 2015.
Historically low unemployment is finally starting to stoke inflation fears, which have weighed on the longer end of the
treasury yield curve. The Fed has signaled that another rate increase in December is likely, but that is dependent on a
number of factors, including economic growth and inflation. Furthermore, the Fed has removed the term
“accommodative” from its statement in describing its policy stance, reflecting the Fed’s attitude that monetary policy
should be tightened given the improving economic backdrop.
Global Trade and Tariffs
Trade disagreements continue between the U.S. and China as each country has increased the amount of goods
impacted from the tariffs on one another. The U.S. has now implemented tariffs on $250 billion of Chinese exports, while
China has retaliated with $113 billion worth on U.S. exports. It is important to note that in 2017, the U.S. imported
roughly $505 billion of goods from China and the U.S. exported just $130 billion. While talks continue between both
sides, the impact on our economy has been minimal to date.
U.S. Midterm Elections
Midterm congressional elections continue to dominate the news media and cause uncertainty for investors. Investors
expect that if there’s a change in control in Congress that it may have a negative impact on the markets, as well as
economic programs and policies. Historically, the stock market has averaged positive returns after a midterm election
despite single-party or split control of Congress. Interestingly, when a Republican is president, the stock market has performed best under a split Congress than under single-party control.
Current Tactical Positioning
Our Defensive Equity Strategy stands at an equity exposure of 87% based on the output of our long-term, intermediate-term and short-term models, along with our assessment of market risk. Within these models, investor sentiment is becoming more negative following the recent decline in the S&P 500. We view negative sentiment as a contrarian factor. Therefore, our intermediate-term model score has strengthened over the past week. However, due to the recent decline, our trend factors are beginning to deteriorate. Should our models show further deterioration and market volatility remain elevated, we stand ready to increase our defensive position.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. This recent market volatility also impacted our fixed income portfolios this week. During the past week, our emerging market debt model switched to a “risk off” position, which led us to reduce our EMD exposure and slightly increase our cash position.
On a positive note, we have seen evidence of extreme selling pressure this week, similar to what occurred in February and March of this year. In our opinion, in order to resume the uptrend, we would anticipate that the stock market should experience another base-building process, similar to what occurred following the sell-off during the first quarter this year. We’ve often said that volatility is a reality in investing. Markets go up—and down—and investors need to remain focused on their investment goals and keep their emotions in check. When the markets behave the way they have this week, it can feel like a roller coaster ride to some. While we don’t know the ultimate outcome of this correction, 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 gradual 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 keep you informed.