Global developed equity markets posted strong returns in the first quarter, and some indexes were close to rebounding to last September’s record highs.
The 13.7% gain by the S&P 500 Index was the best first quarter for U.S. equity markets in 21 years. This is particularly notable as it came after a sharp sell-off during the fourth quarter of 2018 when we nearly reached bear market territory. The strong gains have nearly erased all of the losses experienced a quarter ago.
The Intech Equity Market Stress Monitor™, a collection of five reliable market stress indicators, portrays a risk-on environment with fewer signs of stress across equity markets than observed in 2018. Global developed equity markets continue to demonstrate the least amount of risk relative to specific regions, with three of five measures at or near median levels. This improvement in market stability from a year ago is most evident in the U.S. equity market, as developed non-U.S. equity markets continue to show signs of significant strain.
Shift in Capital Concentration
The first quarter rally was led by giant technology stocks, however, breath of the market improved from a year ago, with more than 50% of securities outperforming the index in this first quarter, compared to just 39% of stocks during the second and third quarter rallies last year.
Less Index Efficiency
The largest change since Q4 2018 in all regional markets is a decline in the index efficiency measure in the Intech Equity Market Stress Monitor™, which decreased from extreme readings, a continuation of a trend that began about a year ago. This decline may reflect a less efficient market and increased potential for skilled active managers to deliver improved risk-adjusted returns in the current environment.
Change Return Correlations
The global developed equity market, as measured by the MSCI World Index, also experienced a notable change in the correlation of returns risk metric during the quarter. While the change is a move to more typical levels, coming off historical lows just over a year ago, the increase has been abrupt and reflects rising systematic risk in the global developed equity market.
The European equity market is again the developed market region where we observed the most market strain, with three of the five market stress indicators at extreme values. Correlation of returns changed markedly since last quarter, increasing to more typical levels when compared to historical observations. This is a continuation of a trend that began a year ago, when correlations in European equity markets were near the bottom compared to all historical observations.
Emerging markets are now demonstrating more strain than their developed market counterparts, with four of five market stress indicators currently at extreme levels. The increase in skewness of returns now places the measure in the top decile compared to all historical observations. This increase reflects signs of extreme optimism and a tendency to react more strongly to positive news in this segment.
Any extreme – not only high, but also low – should be taken as a warning that a return to the norm may shock the market and be a source of volatility. We’ve observed a number of such changes this quarter.
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