Six Observations Following a Volatile Week

By Cleo Chang - October 12, 2018

The stock market took investors on a rollercoaster ride before posting solid gains on Friday.  Our senior investment professionals offer their take on the past week’s market activity and their expectations for the weeks ahead.

The sell-off should not erode investor confidence.

We believe the risk of recession is low. Though growth trends are moderating, the global economy, for the most part, is still expanding. Inflation expectations are rising consistently for the first time since the 1970s but muted in historical terms. Consumer confidence remains high.

Volatility reflected sector rotation, not panic.

The market was volatile, but orderly. Trading volume was two to three times higher than normal, but it didn’t approach panic levels. The spike in volatility did not hit the levels we experienced during the February 2018 drop. Further, the difference between the best- and worst-performing sectors was wide. This indicates investors were selective, and it could portend a longer-term shift from growth to value.

Value outperformed growth, but will it continue?

After an extended period of extreme growth outperformance, the market rotated to value in recent weeks. The shift began in non-U.S. developed and emerging markets (EM) in September and accelerated in the U.S. this week. Even after this reversal, we believe there’s room for value to run.  Some quantitative models suggest value outperformance could continue over the next six months. Keep in mind, however, we’ve experienced short-lived periods of value outperformance during the current growth cycle and this could be another head fake.

Growth opportunities remain.

This week’s volatility highlighted the headwinds for cyclical growth companies in the latter stages of economic cycles. Tariffs, rising interest rates and inflation are raising the cost of doing business. Companies most sensitive to the economic cycle will have a harder time passing along these higher costs to their customers. Innovative growth companies with sustainable competitive advantages can raise prices to offset higher costs.

Emerging markets positives persist despite negative news.

Trade worries, the strong U.S. dollar and political tension are grabbing the headlines in EM, but valuations remain attractive and key growth drivers are intact.

  • Middle-class EM consumers are spending more on education, travel and luxury goods.
  • Banks have significant upside potential in EM countries where the penetration of financial services companies is low.
  • China is undertaking an aggressive stimulus effort of lower rates, tax cuts and a devalued currency to offset the impact of tariffs.
  • Investment in infrastructure, technology and clean energy.

Fallout for bond investors was tame.

Though rapidly rising U.S. Treasury yields are partly to blame for the stock market sell-off, the impact on bond investors was muted. Credit spreads are often important indicators of overall economic and financial market health. Generally speaking, they tend to widen as risks rise and narrow when investors are more optimistic. During this week’s sell-off, credit spreads generally held firm, widening only modestly, even within the riskier credit sectors.

Looking Ahead: Investors Shouldn’t Overreact

As we mentioned in our fourth-quarter outlook, we believe we are in an environment where investors and markets will be more selective.  Now is the time to actively identify compelling opportunities and build defenses to help withstand volatility. As always, we encourage investors to stick to their long-term investment programs rather than react to short-term market events like those we’ve experienced this week.

Cleo Chang
Senior Vice President and Head of Investment Solutions
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    The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.