While stocks recouped some of their losses on Friday, last week was another difficult one for equity markets. Volatility – as measured by the VIX Index – traded at its highest level since December 2011, and stock markets experienced their worst three-day stretch in years.
As I write in my new weekly commentary, “The Era of Low Volatility Ends,” last week’s sell-off illustrated two important facts about the global economy. That said, even with these challenges I see equity opportunities for long-term investors. First, here are the two things investors need to know:
Investors are re-calibrating their expectations for global growth, particularly in Europe. As was the case in prior recent weeks, selling derived largely from fears over economic growth (or lack thereof). Consistent with the past few months, much of the worry remains centered on Europe, as last week brought more evidence of the slowdown in the eurozone.
In addition, even the U.S. is not immune to the threat of slower growth, as evident in last week’s weaker-than-expected September retail sales data. However, in my opinion, the United States, whose growth remains in relatively good shape, is still one of the bright spots in a global economy characterized by diverging growth, and while global growth is slowing, another recession is likely not on the horizon. It should be noted, for instance, that beyond the disappointing sales data, other U.S. economic reports last week, specifically industrial production and initial jobless claims, came in strong.
Low inflation is a real risk. Beyond the pace of growth, investors are also justifiably nervous over inflation, or more accurately, the lack of any. While low inflation is typically a good thing, when it crosses the line into deflation, companies lose pricing power, debt becomes a bigger burden and, as Japan has demonstrated over the past 20 years, central banks have a difficult time getting prices to rise. While most deflationary concerns are focused on Europe, recent readings suggest that unusually low inflation is a global phenomenon impacting the U.S. as well. The drop in inflation has led to a corresponding decrease in U.S. inflation expectations since August, which in turn has resulted in a decline in U.S. Treasury yields over the same period.
As for what this all means for investors going forward, while investor sentiment has clearly shifted, economic fundamentals remain relatively stable. As such, recent losses have also resulted in two potential opportunities for long-term investors.
Maintain exposure to global equities. In my opinion, the recent sell-off is a mid-cycle correction rather than the start of a bear market and, as such, I’d maintain exposure to global equity markets. If anything, the recent drop in interest rates, coupled with the decline in stock valuations, provides an even more compelling case for the asset class as offering better long-term return prospects than bonds.
Favor large- and mega-cap stocks. These market segments have held up better than their small- and mid-cap counterparts in the last few weeks, providing a bit of cushion from the volatility. And with the recent sell-off having made them more attractively valued, I suggest investors continue to emphasize larger capitalizations, particularly with more volatility likely on the horizon.
Sources: BlackRock research, Bloomberg
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any security in particular.
©2014 BlackRock, Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries. All other marks are the property of their respective owners.