After a short week of trading, all major global equity indexes finished the week with negative performance. In the US alone, a tumultuous four days were highlighted by Amazon briefly joining Apple as the second company ever to reach a 13-figure valuation, CEO’s of major technology companies testifying before congress about data security again, public attacks on large tech companies like Google and Amazon from both sides of the political spectrum, and 2 executives departing from Tesla. As has been par-for-the-course internationally for the last 6 months or so, trade discussions dominated concerns as the US, Mexico and Canada work towards replacing NAFTA. Additionally, emerging markets equities continued to sell off as fears of contagion increased.
S&P 500: 2871.79 (-1.0%)
FTSE All-World ex-US (VEU): 50.52 (-3.0%)
US 10 Year Treasury Yield: 2.94 (+0.08)
Gold: 1196.32/oz (-0.4%)
EUR/USD: 1.156 (-0.03%)
- Monday – Markets Closed in observance of Labor Day
- Tuesday – Amazon joins Apple as the second company to reach a $1 Trillion valuation (ultimately closing the week down 3.01%)
- Wednesday – The Technology sector drops 1.5% amid regulatory concerns
- Thursday – The MSCI Emerging Markets Index enters bear territory, down over 20% since reaching an all-time high in January
- Friday – Tesla shares fall 6.30% after Chief accounting Officer Dave Morton resigns after 1 month on the job and videos surface of Elon musk appearing to smoke marijuana during an interview
- Friday – President Trump signals readiness to initiate tariffs on an additional $267 Billion in Chinese goods
While this market volatility may be a change from the past 2 years or so, it is normal over the long term and is something we account for when we construct investment portfolios. For context, the CBOE Volatility Index (VIX) which measures the implied volatility of the S&P 500 index, has a historical mean is close to 20, and historical mode is between 12 and 13. We spent most of 2017 below 10 and finished this week at 14.88.
So, there’s certainly been an uptick in 2018, but we’re still below historical averages. This week, a good portion of volatility was driven by the “FAANG” stocks—a trend that could certainly continue given their growing weight in broad market indices. As of close of business Friday, the top 10 companies by market share in the S&P 500 made up over 20% of the index, with Apple, Microsoft, Amazon, Facebook and Google making up over 15% by themselves. That’s a sizeable amount of concentration.
This means with the recent run up of technology stocks, and FAANG stocks specifically, a cap weighted portfolio may be significantly less diversified than investors realize. One of the core tenets behind diversification is reducing unsystematic risk, or the risks associated with one single company that do not affect the general market. This concentration can be beneficial during good times but can be disastrous during market reversals and recessions. As capitalization weighted indices concentrate more and more towards the largest companies, the levels of stock-specific risk will inherently grow as well. We’re not saying investors should completely avoid these companies, but they should at least be mindful of their exposure. Just because they own an S&P 500 fund, it doesn’t mean they’re properly diversified.
Emerging markets have also had a wild ride. So far, EM assets are being sold somewhat indiscriminately while developed markets have remained mostly immune. Three major influences driving volatility in emerging markets are rising US interest rates, contagion fears, and trade war scares. Argentina and Turkey have serious problems and places like Brazil and South Africa are stagnating. However, we do not expect issues in smaller Emerging Markets countries to meaningfully impact growth in developed markets or threaten the bull market. While select countries and economies are in very bad shape, emerging economies and balance sheets in aggregate are fairly solid, especially compared with previous periods of stress. We believe emerging markets have always come with higher volatility but retain fantastic growth opportunities and diversification benefits over the long term.
Matthew Vibert, CFA
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