Key Takeaways:

·         Global markets are grappling with volatility across asset classes and regions. The S&P 500, for instance, experienced its worst start to a year ever and is now at its lowest level since April 2014.
·         Markets are dealing with a “perfect storm” of sorts - weak global growth, continued volatility with oil prices, diverging central bank policy, and uncertainty about the Chinese economy.
·         In response, investors have poured money into traditionally safe, less risky investments such as U.S. Treasury funds and gold, which have seen $11bn and $4bn in YTD inflows, respectively.
·         More abrupt market swings are likely ahead, yet to us the present downturn looks like another painful but temporary correction instead of a global bear market. Therefore, clients may need help finding growth and stability in this new paradigm.   Dividend growers and minimum volatility funds may be options.

What Happened?:

China – Remember the first trading week of January? Chinese economic data fell to a seventeen month low, sparking global market volatility. This measure indicated that the nation’s services sector – the biggest contributor to national gross domestic product – was in contraction, causing some to fear that the world’s second largest economy was slowing down faster and heading for a hard landing.  Our take – although China had its slowest growth year in a quarter century in 2015, the latest data suggests that chances of a hard landing are low. 

Oil – Still-high oil inventories and potentially lower demand globally have continued to push oil prices lower. WTI crude oil, for example, closed below $27 a barrel in late January for the first time since 2003 and is currently down 20% YTD.

U.S. equities – U.S. stocks have moved in lockstep with oil prices this year, despite the energy sector representing a mere 6.5% of the S&P 500. For much of January, the correlation between oil price movements and the S&P 500 was at levels not seen since the 1990s – a rare coupling that highlights fears of a global slowdown. Moreover, we’ve seen lower revenues this earnings seasons. Many multinational corporations (such as Apple, which obtains 66% of its revenue outside the U.S.) cited the relatively strong dollar and weak global demand as headwinds. With concerns about global growth in mind, investors are looking ahead to Yellen’s testimony before Congress tomorrow and Thursday for any sign that the Fed may ease off previously expected plans to continue raising interest rates this year.

Policy Actions – Central bank divergence continues. While the Fed lifted rates off historical lows in December, the ECB and BoJ took accommodative actions last month to address continued low inflation levels in their economies (caused in part by falling oil prices.) The ECB signaled additional monetary easing in March, noting that the outlook for Eurozone inflation had weakened “significantly.” A week later, the BoJ surprised global markets overnight by lowering its benchmark interest rate from 0.10% to -0.10%, the first benchmark rate move in five years and first negative rate move ever. The announcement represents the BoJ taking dramatic action against long-term deflationary conditions. By adopting negative interest rates, the central bank is essentially charging commercial banks for parking excess reserves, prompting them to lend more and deposit less, and thereby increasing the amount of money in circulation.
Market Reaction:

Amidst global volatility, investors have largely reacted by flocking to safe, less risky assets, which has driven up their prices. Notable examples include:

U.S. Treasuries – Treasuries have re-emerged as a top destination for investors seeking to stash capital. The yield on the 10-year Treasury note fell to 1.725% today, dropping to its lowest level in a year in a flight to safety.
Japanese sovereign debt – Japanese government bonds yields have also continued to fall, as the 10-year yield went negative to -0.02% today for the first time ever. This is a big deal because it means investors are actually paying the government 2 basis points to hold their money for 10 years. Japan joins Switzerland as the only countries with negative 10-year yields.
Yen – Regarded as a safe haven among Asian assets because of the stability of Japan, the yen strengthened to its highest level against the dollar since 2014.
Gold – Historically a safe haven asset because its value is not impacted by interest rates, gold has moved sharply higher in recent trading sessions and is one of the best performing assets YTD. Gold jumped 3.5% yesterday, its largest one day gain in nearly four months.

Investment Implications

Market conditions have changed but there are still actions investors can take to achieve growth while maintaining stability. Potential opportunities include:

DGRO – Investors may want to approach the current turmoil from a different perspective, and focus instead on total return strategies, including dividend growth. For example, DGRO can help provide investors with exposure to companies screened for quality balance sheets and sustainable growth. Dividend growers may help investors weather evolving markets while seeking to generate sustainable yield.

USMV – Long term investors who are looking to minimize volatility in their core portfolios may want to consider minimum volatility funds. USMV is explicitly designed to help investors weather the ups and downs of the U.S. stock market by seeking to track an index composed of U.S. equities that, in the aggregate, have lower volatility characteristics relative to the broader U.S. equity market. USMV serves as a long-term, core portfolio holding that can help investors remain in the market amidst volatility.

Heidi Richardson is head of investment strategy for U.S. iShares.