Investors who stuck with their portfolios through the heightened volatility of the fourth quarter of 2018 were rewarded in January, and had positive results again in February. All our core equity asset classes had positive returns, albeit at about half the levels they had in January. Fixed income assets had more mixed results last month, though only long-duration US Treasuries have a loss year-to-date (Fig. 1).

Fig. 1: Equities continue their strong run

Total returns by asset class

While lower than in January, US equities had the strongest performance across asset classes in February, with the S&P 500 notching a 3.1% gain for the month. After starting February strongly, US equities traded sideways in the second half of the month. We expect the market to continue to rise at this more gradual pace (Fig. 2).

Fig. 2: Positive but lower growth for US equities

S&P 500 growth for January and February

Another trend that occurred in February is the continued noticeable decline in asset volatility. As is typical with a strong equity market rally like the one we have seen recently, the VIX has retreated back to levels last seen in October 2018. On top of the drop in the VIX, the MOVE and JPM VXY indices also fell meaningfully (Fig. 3).

Fig. 3: Lower volatility could mean too much complacency

VIX, MOVE, and JPM VXY indices

These measure the implied volatility of US Treasuries and G7 currency pairs, respectively. The MOVE has only ever been this low two other times in its history going back to 1988, while the VXY has only been this low on two days (in January 2018) since 2014.

While this lower-volatility regime may be comforting to investors, it gives us reason to pause. It is uncharacteristic for markets to be this sanguine at this stage of the business cycle. As we highlighted recently in "Navigating volatility throughout the business cycle", markets can continue to have strong returns in this late stage of the cycle, but volatility should remain more elevated. Low volatility isn't typical at this point in the cycle and we would anticipate this recent trend to reverse course. We stress that investors stick to their plan and remain invested, even if volatility reemerges.

The bottom line

The economic conditions that have supported the rally thus far should continue and remain supportive of our current positioning. Positive developments on the US-China trade front, coupled with dovish Fed policy and meaningful fiscal easing in China, support our current equity overweights to the US and emerging markets. While we remain overweight these two regions, this month we dialed back overall equity exposure and took a more defensive posture within our equity allocation. Additionally, we continue to hold a tactical position in long-duration US Treasuries, which should perform well in the event of an equity market sell-off.

Author:

Jason Draho, Head Asset Allocation Americas, UBS Financial Services Inc. (UBS FS) Michael Gourd, Investment Associate Americas, UBS Financial Services Inc. (UBS FS)

Appendix

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