Equity market volatility has spiked as investors panic, but they may be overlooking the long game
Following last week’s move of the 10-year U.S. Treasury yield below that of its two-year counterpart’s — a scenario that hadn’t happened in 12 years — investors were agitated into selling off risky assets, including both stocks and oil. The move is understandable, given the historical tendency for economic recessions to succeed such drastic yield-curve inversions.
Volatility in the equity markets has spiked amid a frenzy for fixed income and other safer assets. But as Martin Pelletier, CFA, portfolio manager, and OCIO at TriVest Wealth Counsel has noted, investors may want to think carefully before making any moves out of stocks.
“[D]uring times like these, it’s imperative that one avoids getting caught up in the headline reporting and remains focused on playing the long-game,” he wrote in a piece on the Financial Post.
He observed that corrections are part of a normal functioning market. The S&P 500 has an average of three corrections totalling more than five per cent every year, though it varies; while there were no corrections in 2017, there were five in 2018. Looking at the Dow Jones, Michael Batnick of Ritholtz Wealth has pointed out that the Wednesday sell-off was the 307th time the index underwent a decline of more than 3% in the past 100 years.
“It is also important to understand that economies and equity markets do not always move together,” Pelletier continued. While conventional thinking would assume that recessions hurt corporate profitability and share prices, he noted several studies showing moves in the opposite direction.
That includes research from the Bespoke Investment Group, which found that a 52-week low in the yield of the 10-year Treasury Note is always followed by higher average forward returns for the S&P 500 in the following day, week, month, three months, six months, and year. A longer-term picture resolves from data from LPL Financial and cited by MarketWatch, which indicates that one, two, and three years following an inversion, the index returned 13.5%, 14.7%, and 16.4%, respectively.
“The bottom line is no one is able to predict near-term moves in the market as there are too many factors at play that could have an impact either way,” Pelletier stressed, noting that a positive surprise from any resolution to the U.S.-China trade dispute would greatly lift the markets.
Suggesting that the recent pullback represents a good test of one’s willingness to use downside moves to capture long-term upside potential, he pointed out that nearly three quarters of stocks in the S&P 500 offer a dividend yield that’s better than the current 10-year Treasury rate.
Domestically, he said, many blue-chip equities — banks, insurance companies, and pipelines, to name a few — offer dividend yields anywhere from 4% to 7%. In contrast, the 10-year Bank of Canada yield stands at 1.2%. Canadian oil stocks, he added, are trading at their largest-ever discount to oil prices, with many offering a sweetener in the form of dividend yields exceeding 5%.
“We tend to look to the bond market as a means of managing the volatility in one’s portfolio while deploying a diversified approach to owning equities across various segments of the market and geographic regions,” he said.