Mid-October 2018 Volatility

Market Update by David A. Klassen, Chief Investment Officer

What is happening in the markets?

It is October again, and volatility has returned to U.S. equity markets after a long period of uncommon stability and resilience. This prior resilience at home took place against the backdrop of negative performance in international developed indices in Europe and Japan, as well as emerging markets like China and Brazil. Now, U.S. stock markets have turned down rapidly.

What is the cause of this selloff?

The global economy started diverging in 2018, which means that countries and regions around the world stopped growing together like they did in 2017. Growth in the U.S. has been better, partly because growth here started earlier, but also because of shorter-term tax policies. The U.S. Federal Reserve has continued to raise rates, and market participants have now factored future rate increases into lower prices and higher yields. One additional negative is that U.S. companies have begun to admit that they are impacted by the higher material prices brought on by increased tariffs.

What is likely to happen?

Although prices have declined, economic fundamentals are still positive, and earnings are still growing. Growth forecasts by the International Monetary Fund (IMF) have been reduced slightly, but a recession is not imminent. U.S. equities are now less extended, given strong earnings growth, and international equities are becoming even more attractive. On the flip side, higher interest rates are a concern, as the 32-year bull market in bonds is likely behind us. Unsustainable deficit and projections for programs such as Social Security in the U.S. may affect markets and negatively impact the dollar in the future. That could begin to swing the tide back to international investments.

The selloff will also likely create opportunities for some of the nimbler managers in the Pension Boards’ investment program. Volatility on the downside can quickly turn to volatility on the upside. At some point, bonds become attractive again as yields rise.

How is the Pension Boards reacting?

We had reduced equity exposures in balanced funds (including the Balanced Fund and the Target Annuitization Date Funds) over the summer and raised some cash. We also had been positioned with a lighter-than-benchmark exposure to international developed managers. Additionally, we had reduced our exposure to emerging markets by reducing assets committed to one of our managers. In fixed income, our positioning includes a healthy dose of floating-rate bank loans, which benefit in a rising interest rate environment.

International equities are attractive, and many of those economies are behind the U.S. in their recovery, with better earnings potential. We continue to favor diversification, since that is the way to generate the secure returns necessary to help accumulate retirement assets. The possibility that international investments outperform U.S. investments over the next few years remains real, and many advisors, including ours at Goldman Sachs Asset Management (GSAM), urge staying the course.

In that light, we encourage you to engage the free financial planning services available to actively contributing Annuity Plan members through Ernst & Young. Contact an EY financial planner at 1.877.927.1047 (Monday through Friday, 9:00 a.m. to 8:00 p.m. ET) to evaluate your positioning and allocation for the environment ahead.