This article was co-authored by John Bussel, co-Chief Investment Officer of Hewins Financial | Wipfli Hewins.
Last week was another volatile one in the market, with the S&P 500 down by almost 6% on fears of a trade war, the Federal Reserve’s interest rate hike and the use of personal data by social media companies. This marked the second straight week of losses for the U.S. equity market; these two weeks of losses erased the gains made earlier in the year. At the time this letter was written, U.S. stocks have rebounded as the initial fears of a trade war have subsided.
What is going on?
Volatility is something that investors can expect when investing in stocks, and there is usually a different issue or set of issues causing market angst in a particular time period. So what is it this time, and more importantly, should you be concerned?
A few factors appear to have contributed to the recent bout of market volatility:
Facebook Data Privacy
Facebook came under fire last week for inadequately responding to a security breach of its users’ data by a third-party application.1 The U.S. and U.K. governments have requested a formal inquiry into the matter. Facebook’s stock lost as much as 14%2 of its value over the course of a few days, as many feared user backlash and a step up in regulations that could hurt the company.
Facebook has been one of the strongest stocks in the U.S. market over the past few years — one of the beloved “FAANG” stocks (Facebook, Amazon, Apple, Netflix and Google) that made up 12.5%3 of the S&P 500 Index. Its recent fall from grace is a good example of why we take a diversified approach to investing. Although Facebook’s stock was down 14% last week, the information technology sector as a whole actually gained 1.8%. Diversification reduces the idiosyncratic (or company-specific) risk associated with a stock. This is an important risk management tool because being diversified limits the negative impact of one stock on the overall portfolio.
Even if Facebook has some more issues ahead, investors with well-diversified portfolios should rest easier because they’re exposed to thousands of stocks, not just a few.
The Fed and Interest Rates
Last week, the Federal Reserve lifted the overnight federal funds rate by a quarter-point to a new target of 1.5–1.75%. This was the sixth interest rate hike since the Fed started raising rates from zero in December 2015. It was also the first hike under the new chairman, Jerome Powell.
Markets are concerned the Fed may end up raising rates as much as three more times in 2018 to fight increased inflationary concerns — but these hikes could also end up hurting economic growth and earnings. For now, it seems two more hikes this year are more likely than three, but markets will continue to look closely at economic data and indications from the Fed Board of Governors for clues on future policy.
Tariffs and Fear of Trade War
While concerns about Facebook had an impact on the company’s stock and the technology sector, and the rate increase caused some overall gyrations, the U.S. administration’s announcement regarding tariffs had even wider market implications for increased volatility.
A few weeks ago, the administration announced tariffs on imported steel and aluminum. Many U.S. companies use imported steel and aluminum as inputs in their products, and the tariffs would increase costs for these companies. Another concern is that U.S. tariffs will cause retaliation from trade partners, leading to a trade war that would hinder global growth.
While these are legitimate concerns, it is difficult to parse what is a negotiation tactic from what will actually take effect. In fact, toward the end of last week, several trade partners — namely the European Union, Canada, Mexico, South Korea, Australia, Argentina and Brazil —received temporary exemption from the steel and aluminum tariffs. Additionally, while China’s first reaction to the tariffs was retaliatory — it announced counter-tariffs on U.S. goods — the tone between the U.S. and China has now become more conciliatory.
While we cannot rule out the possibility of continued market anxiety and volatility over this issue — especially since there is considerable uncertainty over if, how and which companies and countries may be impacted specifically — a well-diversified portfolio is an investor’s best defense, as stated in the previous example. There will be some stocks that inevitably benefit from the changes that take place as a result of revised trade agreements, and a globally diversified portfolio helps ensure that investors will have exposure to them.
Periods of uncertainty and volatility can prompt investors to consider drastic measures that are harmful to the long-term wellbeing of their portfolio. Remember, volatility means there can be large jumps on the downside and the upside (as we have recently witnessed); that’s why tuning out the short-term noise is essential. Maintaining discipline through these times can be challenging, but over time, that discipline is what can lead to long-term returns.
