Volatility Returns to the Equity Markets

February 7, 2018  | by Kristofer Kwait, Steve Snyder

Equities | Investment Strategy

During the course of the recent sell off in the equity markets and spike in volatility, many of our investors have questioned whether this significant drop experienced over a few trading days portends the beginning of a bear market, or a shorter term correction (albeit a violent one). 

As noted in our year-end letter, we acknowledge many investors’ sentiments that we may be late in the market cycle as evidenced by the following:

  • Higher equity valuations (current P/E Ratio of 25.4 versus long-term average of 15.7)

  • Narrow markets (nearly a quarter of the S&P 500 Index return for 2017 was driven by six companies)

  • Large dispersion between growth and value (growth outperformed value by 1432 basis points in 2017)

Notwithstanding this, we do not think late cycle means the end of a cycle for several reasons:

  • Low interest rates coincide with higher equity valuations, providing support

  • We still see synchronized global growth around the world

  • There remains strength in earnings as noted in the chart below

CH1-Earnings-Estimates

The strong earnings, in turn, have led to the persistence of an equity risk premium above the normal average.

CH2-EquityRiskPremium

Clearly, volatility has returned in dramatic fashion over the last few trading days and we expect perhaps more volatility and divergence as the cycle ages.  Our market view has not changed, and we believe that market fundamentals continue to support a modest equity overweight relative to policy portfolios. 

While we monitor many factors that influence our point of view, there are two primary indicators that would likely result in a change in our view of favoring this modest overweight to equities:

  • Higher yields – If the 10-year Treasury Yield increases to 3.5 percent, it would likely eliminate the excess equity risk premium. We remain well off of that level as shown in the chart above.

  • Earnings not meeting expectations – This is especially true in the United States where valuations are highest, as it accounts for approximately 25 percent of the global economy and nearly 50 percent of the global equity market capitalization.

Our guidance for investors is to focus on and stay consistent with your investment policy, rebalancing appropriately and confirming that your policy remains consistent with your return expectations, risk tolerances, and liquidity needs. 

Authors

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Kristofer Kwait is Deputy Chief Investment Officer, and Head of Investments responsible for leading the marketable equities, fixed income, hedge funds and real assets investment teams as well as analytics. Prior to his current role, Kris was head of the Hedge Fund Strategies Group. Previously, he served as head of hedge fund research with responsibility for overseeing the design and implementation of proprietary models for manager selection, portfolio construction, and risk management. Before joining Commonfund, Kris was a proprietary trader at both Andover L.L.C. and A.B. Watley, where he managed relative value equity strategies. Prior to his experiences as a trader, he was a stockbroker at Smith Barney. Kris attended pre-college at Juilliard School of Music, has a B.S. from Purdue University and an M.B.A. from the Yale School of Management.
Kristofer Kwait
Deputy CIO and Head of Investments
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Steve Snyder is Head of Relationship Management for Commonfund and is involved in all areas of the investor experience from policy development to portfolio implementation and oversight. Steve has over 20 years of experience in the banking, treasury and asset management. Prior to joining Commonfund, Steve previously was a Cash Management Consultant supporting the education industry for CoreStates Bank, N.A., and First Union National Bank in Philadelphia, PA. He currently serves on the Investment Committees of the University of the Sciences in Philadelphia and recently completed several terms as an Investment Committee member for Lancaster County Community Foundation. He is also a member of the President′s Business Council at the University of Scranton. Steve has a B.S. in Finance from the University of Scranton.
Steven C. Snyder
Managing Director
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Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.