Equity and fixed income return volatility

Williams 150x150Dan Williams, CFA, CFPInvestment Analyst

People need no help picturing equity return volatility. Anyone invested in the equity market in the middle 2000s still likely feels the scars from the subprime mortgage crisis. Prior to that, there was the dot com burst of the early 2000s. The dark side of equity return volatility is double-digit loses in a short period of time that can take years to recover. It is for that reason equity investing is best for time horizons that are also double-digit in years. However fixed income volatility is more subtle in nature and although people know to try to avoid it, it is not as widely understood.

Volatility for investments is often represented by the standard deviation which most understand has to do with the range of returns that are experienced around the average return. However, knowing the term and understanding what the term represents are two separate matters. Volatility in traditional fixed income securities is driven by the two factors: changes in the rates that securities of similar risk should pay and how long you are locked into receiving the coupon rate of a given security. The magnitude these market rates changes impact the principal value of the fixed income instrument is driven by how long an investor is locked into a given rate as the duration of a bond. Accordingly, the fear of rising raters has driven investors to try to lower the duration of the bonds they own to lower the price hit or even to avoid fixed income securities.

One thing that differs between equity and fixed income volatility is what happens with returns after there is a downward movement in price. When an equity goes down in value it is likely due to the consensus judged future prospects of the equity having gone down. For a fixed income, as long as the future ability of the instrument has not come into serious question, the short-term hit comes due to the market view of rates required for payments having increased. In other words, equities go down because things have gotten worse while for fixed income prices go down because the market feels you should be paid a higher rate going forward.

As way of example, consider a diversified portfolio of bonds like that represented by a Bloomberg Barclays US Aggregate Bond replicating investment like the iShares US Aggregate Bond ETF (AGG) or the Vanguard Total Bond ETF (BND). Currently, the duration is about 6 and the 30-Day SEC Yield is about 3%. If rates rise by 0.5%, these securities will take about a 3% price hit (not precisely due to convexity but close enough). Going forward the SEC Yield should rise as bonds now are lower priced but pay the same coupon amount and new bonds are bought with higher coupons. The income return on a new dollar invested is now expected to be over 3% but a 3% hit was taken on the principal amount invested. Despite the feared rate hike occurring, the net return is still projected flat or maybe even slightly positive for the 12-month period.

Another way to picture this return volatility, we can look at the actual annualized 36-month, 84-month, and 120-month rolling periods for the Bloomberg Barclays US Aggregate and Russell 3000 Index since the start of 1994, 25 years ago. During this period there existed no 36 month period where Bloomberg Barclays US Aggregate failed to deliver a positive absolute return and as increasingly longer periods are looked at the range of actual outcomes settles into a 3% to 8% range. Alternatively, equity still possesses a few very unlucky 120-month (10-year) periods with a negative return as well as periods of annualized returns in excess of 14%.

Equity fand fixed income return volatilityIt is for this reason that longer time horizons are prescribed for equity investing and time horizons of 3+ years are regarded as reasonable for holding a diversified fixed income exposure. Finally, it would not be an investment blog if it was not pointed out that these extreme return periods often occur at different times for different asset classes and intelligent diversification gives better return range confidence. Better investment return confidence leads to increased ability to plan and better planning usually leads to better outcomes.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.


Volatility vanishes (again), but it should be back (again)

Holland_F_150x150Tim Holland, CFA, Senior Vice President, Global Investment Strategist

More than once last summer, we were asked our thoughts on the early 2018 spike, and subsequent drop, in market volatility as measured by the VIX, Wall Street’s “Fear Index.” We noted we weren’t surprised by the return of volatility, an accelerating economy and rising rates were expected catalysts, nor its departure. We also believed volatility would be back, and back it was in the fourth quarter, before it vanished again. Given the rather volatile behavior of late – well, market volatility – we thought now was a good time to touch base on the topic.

To back up, in early 2018 the VIX spiked to 40 and the S&P 500 Index sold off sharply on a January jobs report that showed greater than expected wage inflation. While the economy and the market welcome modest inflation, an ever-present concern is accelerating inflation that forces the Federal Reserve (Fed) to raise interest rates aggressively, ultimately pushing the economy into a recession and stocks into a bear market. When there was little inflationary follow through post the January jobs report, and economic and earning reports continued to top expectations, volatility declined sharply and the market rallied strongly. That is until Q4 as investors grew concerned the Fed would raise rates and shrink its balance sheet more than economic and market conditions merited, and the US and China would enter a full blow trade war, the VIX spiked and stocks corrected. Then, as the Fed walked back its hawkish talk on rates and its balance sheet, and we received more good news than bad on the state of US/China trade negotiations and economic data came in largely as expected, the VIX peaked and the S&P 500 bottomed in late December. Since late December, the VIX has collapsed 23 points and the S&P 500 has rallied 19% – see the below chart for a look at volatility through 2018 and into 2019.

CBOE Volatility Index

While we welcome the move higher in the S&P 500 and the decline in the VIX, we doubt we have seen the last of market volatility, with potential catalysts including better than expected economic growth and US/China trade relations. However, a bumpy market isn’t a bear market, and as long as fiscal policy and monetary policy remain accommodative, and inflation contained, US equities should be biased higher.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Chart source: FactSet


Vlog – Quarter End Q&A: 4Q2018

Brinker Capital Global Investment Strategist, Tim Holland, CFA, asks and answers those questions we think will be top of mind for clients as they open their quarterly statements and think back on the quarter that was:

  1. Why did US equities correct so sharply in 4Q2018?
  2. Why was the market so volatile in 4Q2018?
  3. Is the bull market over?


The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a registered investment advisor.

Top blog posts of 2018

It’s time to close out the year with our top five blog posts from 2018. From our perspectives on market volatility to weekly podcasts and even a recap of the mid-term elections, these are the best of 2018. Enjoy!

Crosby_2015-150x150Dr. Daniel CrosbyExecutive Director, The Center for Outcomes & Founder, Nocturne Capital

The do’s and don’ts of market volatility

You will never regret your vacation

A tomorrow more certain than today


Tim Holland, CFA, Senior Vice President, Global Investment Strategist

Investment Insights Podcast: What’s roiling the market, and where do we go from here?



Jeff Raupp, CFA, Chief Investment Officer

A quick take on the mid-term elections



The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Drivers of recent market volatility

Holland_F_150x150Tim Holland, CFA,
Senior Vice President, Global Investment Strategist


Throughout 2018, Brinker Capital has been optimistic about both the US economy and US stocks, however, recent market weakness and volatility beg two questions:

  • Is Brinker Capital still optimistic on the US economy and US equities?
  • If so, why?

To answer both questions, we remain optimistic on the US economy and markets into 2019. We are overweight US and emerging market equities and conservatively positioned within fixed income, as we continue to see interest rates biased higher. Additionally, we remain optimistic as the fundamental data continue to point us in that direction.

More specifically,

  • The US economy should grow north of 3% in 2018 and about 2.5% in 2019.  We see very little risk of a recession in the new year.
  • US corporate profits should grow north of 20% in 2018 and mid to high single digits in 2019.  Continued growth in earnings is important for a few reasons, including the fact that we haven’t had an economic recession without an earnings recession (e.g. when US corporate profits decline year-on-year) and that as earnings move higher and the market trades down, stocks become more attractively valued.
  • None of the classic indicators of a recession, including an inverted yield curve, restrictive monetary policy, or a rolling over of leading economic indicators are present today.  In fact, one could argue that the US economy is doing exceptionally well, with unemployment below 4%, GDP growth above 3% and inflation anchored near 2%. Also, the recent dramatic drop in the price of oil will translate into lower prices at the pump for US drivers, a powerful economic tailwind when considering our economy is 70% consumer driven.
  • Pivoting back to the US equities, not only is the market attractively valued at below 14x forward earnings, 2018 should see US companies pay a record amount of dividends and buy in a record amount of their own shares. Both are important pillars of support for stocks.
  • Many measures of Investor Sentiment are at or close to all-time high levels of pessimism. This indicated that many investors have capitulated and return expectations moving forward are very low. In this environment, news that is even incrementally positive can have a substantial upside impact on markets.

So, if the fundamental data is so robust, why has the market been so volatile and biased lower? We would point to two primary concerns. First, the US Federal Reserve (Fed) is pushing interest rates too high too quickly, which will ultimately lead to a slowing of corporate and consumer spending and a recession. Second, the US and China won’t be able to resolve their differences on trade, with escalating tariffs ultimately pushing the Chinese economy into a recession, which will pull down global growth and possibly cause a recession here at home.

We believe both risks are real and meaningful, however, we also continue to believe that the Fed will move quite slowly on interest rates next year and that cooler heads will prevail on trade.  In fact, the Fed has made it quite clear they will be data dependent when it comes to interest rate policy in 2019 and the US and China recently agreed not to impose any additional tariffs during a 90-day negotiating period.  We expect good news on the trade front sooner rather than later.

Market drawdowns are never pleasant, but they do happen.  And when markets sell off it is important to keep one’s focus on the fundamentals and away from the media’s bias toward fear-mongering and frightening headlines.  Today, the fundamental underpinnings of both the economy and market remain robust and as a result, we remain optimistic on both into 2019.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Brinker Capital, Inc., a registered investment advisor.

Investment Insights Podcast: Unpleasant, yes; deterioration in fundamentals, no

Amy Magnotta, CFASenior Vice President, Brinker Capital

On this week’s podcast (recorded October 26, 2018), Amy discusses the recent market volatility.

Quick hits:

  • The S&P 500 Index is down -7.6% from its September high, but has not yet reached official correction status.
  • Third quarter earnings have been stellar for the most part.
  • Investors have a number of concerns that are weighing on markets.
  • We continue to believe that the positives outweigh the risks, and we do not see that a recession is imminent.

For Amy’s full insights, click here to listen to the audio recording.

investment podcast (32)

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a registered investment advisor.