Global equity markets recorded sharp declines during the second quarter as investors grew concerned that rising interest rates may not be enough to tamp down inflation without causing a recession. Volatility increased, and the sell-off accelerated in June, leading to a substantial drawdown during the year’s first half. U.S., Global, and non-U.S. markets all saw very similar declines as markets moved nearly in lockstep.
The 24% equity market drawdown is the 10th worst in the history of the S&P 500 Index, but still well below the average level of 35% as measured by the 15 most significant equity drawdowns (see table below). In terms of duration, the current drawdown of 118 days is well below the average of about 268 days observed historically. The current drawdown has been severe, to be sure, but as the table below shows, the markets have seen much worse, including three in the last 25 years. From a historical perspective, there may be quite a bit of potential downside left.
During the first half of the year, over 50% of trading days show a fluctuation greater than 1%. We have not seen this amount of daily volatility since the global financial crisis in 2008, and we see no reason for volatility to subside in the third quarter, as the global macroeconomic catalysts show little sign of abating.
Value stocks have become more defensive during the year, creating a significant risk divergence relative to growth stocks, as measured by their beta in the next chart. While some see value stocks as inherently defensive, the reality is this relationship tends to be cyclical, with growth and beta trading their beta positioning relative to the total market over time. We would expect this divergence to normalize in the long term, as it has before.
Defensive equity indexes outperformed their broad market equity indexes during the first half (see below). The outperformance of defensive stocks has been extensive – and can be cyclical over time – but an allocation to defensive stocks has advantages in a multi-asset portfolio. Given the current uncertainty in equity markets (and over a full market cycle), we believe an allocation to a defensive equity implementation makes sense.
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