Equity volatility has increased, but put it into perspective
After a period of abnormal calm, equity market volatility has returned. Fears of a trade war, higher inflation prompting faster Fed tightening and concerns about tech stocks have driven the increased choppiness in equities. But there are signs that all of these threats may be less severe than feared. Analysts recommend that investors stay invested, but consider downside protection and counter-cyclical positions to protect against tail risks.
The S&P 500 has moved by more than 1% in either direction on 22 days since the end of January – more occasions than over the entire prior 17 months. Faced with renewed choppiness, investors might be tempted to withdraw from risk assets. But while investors should gradually phase in trades that hedge against tail risks, such as our overweight in 10-year US Treasuries, good reasons to stay invested do remain. Global economic data is still beating forecasts, based on the Citi Economic Surprise Index. And the threat from accelerating inflation, a trade war, or a turn in tech stocks may be less severe than feared.Tough talk on trade has been unsettling markets. But the US has already significantly diluted tariffs: country exemptions mean that two-thirds of the import tax on steel has now been suspended, and over half of the tax on aluminum. The US has also successfully revised a trade deal with South Korea, once branded by Trump as a "job killer." And behind the tough talk from both sides, negotiations are going on between the US and China, with US Treasury Secretary Steven Mnuchin optimistic that talks could avert the need to impose tariffs. The risk of a major disruption remains real and rhetoric can boost market volatility.Worries over technology firms have become a major theme, with the sector falling faster than the broader market. In the trading week to 2 April, the tech-heavy Nasdaq Composite fell 4.9%, versus 2.9% for the S&P 500. The risk of tougher regulation on data privacy and concerns over autonomous driving could weigh on confidence further, along with talk of tech-specific taxes in Europe. That may put a cap on valuations for the time being. US tech is still trading at an 11% premium to the S&P 500, in line with the long-run average excluding the tech bubble. But while we are neutral on the sector over the coming six months, the secular growth outlook for cloud, e-commerce, online advertising, and cyber security remains positive.