Washington Trust Bank Blog | Third Quarter Volatility Increased for Stocks and Bonds

Third Quarter Volatility Increased for Stocks and Bonds

The uncertainty over trade and global growth generated volatility throughout the quarter. There has been no progress in the stand-off between the US and China. European growth has slowed, with Germany seeing contraction in the 2nd quarter. Brexit resolution seems nowhere in sight. In Asia, China’s and India’s growth continue to slow. Japan’s economy expanded at 0.4%, surprising on the upside, but this growth may be due to early buying to avoid the hike in the VAT. We’ll see if there is a resulting pullback in growth in the upcoming quarter.

In addition to economic uncertainty, political risk increased as well. The stand-off between the US and Iran resulted in several tanker attacks, the shoot down of a US drone, and the missile strikes on Saudi oil facilities. Despite this, large cap stocks managed to eke out a gain; however, small cap and foreign stocks posted losses. While the S&P 500 gained 1.7%, the Russell 2000 declined 2.4%, the MSCI EAFE lost 1.7%, and the MSCI Emerging Market dropped 4.3%. Year to date, equities continued to provide above average returns with the S&P 500 rising 20.1%, the Russell 2000 gaining 14.1%, the MSCI EAFE returning 12.8%, and the MSCI Emerging Market climbing 5.9%.

As anticipated, the Federal Reserve reversed last year’s course and cut interest rates twice this year. The European Central Bank also loosened policy by reviving quantitative easing and cutting rates to -0.5%. As a result, high quality bonds and high yield achieved modest gains of around 1%.

Because of the Fed’s reversal, we made a shift in our portfolios to profit from the change, replacing our floating rate allocation for exposure to GINNIE MAEs. Along with higher credit quality, GINNIE MAEs are more sensitive to interest rate changes, and returns should benefit from the rate declines.

For the most part, our alternative strategies, both real and absolute return, were able to outpace stocks and bonds. Real return strategies, or strategies that hedge inflation, include real estate, global infrastructure, and commodities. Real estate had a stellar quarter and gained 7.1%. Global infrastructure returned 2.0%. Only commodities, although still positive year to date, detracted from returns and declined 2.25%.

The absolute return, or risk management strategies, which include global macro, market neutral, and managed futures, provided returns between 1.5% and 2.5%.

Although the trade war between China and the US seemed to simmer by quarter’s end, stark differences remain and resolution seems nowhere in sight. Adding to this tension, political risks around the globe have increased. Consequently, we expect heightened volatility to remain.

In July, the US economy entered its longest expansion. Consequently, many are asking how long before the next recession. A couple things to note: historically the quicker the economy has risen, the quicker it has fallen. This expansion has been marked by its slow growth, so a longer period of growth time seems to make sense. Expansions do not die because of age, they generally die because of policy error. The Federal Reserve overtightened in December, but has reversed course ever since. The yield curve is inverted and this has correctly predicted every recession over the last 50 years; however, the onset of a recession has been as long as three years out. Global quantitative easing may be a factor this time, but we remain cautious. While we believe there is little risk of a recession in the near term, we believe risk has risen.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

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