As noted, we expect elevated volatility to persist over the next several quarters, due to both well-entrenched concerns as well as growing uncertainty around fiscal policy and the 2016 election. The recent biotech sell-off provides one example of how the election may influence the markets, as presidential candidates’ comments regarding drug pricing fueled a correction, despite elections being over a year away.
Although markets have been unnerved by the Fed’s recent comments and a policy misstep cannot be ruled out, we do not believe a move to tighten monetary policy will upend the economy or the markets over the longer term, particularly given our expectation for a slow and shallow rate-increase path. In an environment of more muted economic growth where earnings growth is more scarce, we believe growth equities remain more attractive than value stocks. Figure 5 supports this view, illustrating that large-cap growth has outperformed large-cap value when trading at a relative discount to forward P/E.
Recent volatility and a sudden reversal of momentum stocks, combined with a rush into commodity and value stocks, has caught investors off guard in an already difficult market. Figure 6 shows the sudden reversal of momentum stocks, driven mostly by pressure on biotech stocks versus the laggards of the last year: commodity and value stocks. While we will continue to see bear market rallies in commodities, it is our view that the market will eventually focus on the fundamentals, including positive earnings growth and clean balance sheets. So, for the time being we are in the “mean reversion camp.”
International Markets
Over the quarter, international equity markets fell across the board (Figure 7). Emerging market equities began to underperform in late May due to concerns surrounding the Chinese equity markets, while developed markets remained relatively more resilient. Conditions became more inhospitable globally when the People’s Bank of China (PBOC) announced a change to renminbi policy.
Not surprisingly given fears of slowing global growth, markets within commodity-export-dependent economies performed worse over the quarter. By sector, cyclicals underperformed globally, with the steepest declines in energy and materials. While we did see some resilience in the more defensive consumer staples and utilities sectors, other historically defensive sectors, such as health care and telecom, sold off with the broader market.
