In brief
• The pull-back in equities since the start of October is not the result of one event, but a multitude of building risks.
• Pockets of heightening volatility, rather than structural higher volatility are becoming more common. These periods may feel more severe against an extended phase of relatively benign volatility, but are often short lived.
• The potential for strong returns in the final stages of the market cycle provide an incentive to remain invested. Rather than recoiling from equity markets broadly, investors should consider the resiliency of their portfolio and whether portfolios are adequately diversified.
Equity investors have started the final quarter of the year on the back foot. The Standard & Poor’s (S&P) 500 has declined 6.3% since the start of October and the largest daily drop since February of the year was recorded last week. The slide in U.S. equities has been felt globally with most major regional equity indices falling sharply and the volatility rising. The Chicago Board Options Exchange volatility index (VIX) has risen to close to 25, more than doubling from the start of the month.
There is no one cause behind the acute decline in equities, but it’s the result of compounding market fears on a number of macro and micro events. The specter of rising rates still haunts markets, despite this reflecting improving growth. Markets have been adjusting to rising rates, but similar to the equity retreat February, the pace at which yields have moved caused multiples to come under pressure and volatility to rise.
Anxiety is also being fuelled by the worsening U.S.-Chinese relationship, spilling out beyond trade disagreements and showing little sign of a near-term resolution. Now that the rhetoric around higher tariffs is becoming reality, companies are warning of higher input costs that may crimp what have been steadily rising profit margins and the upcoming U.S. earnings season. All of this comes at a time where borrowing costs are rising, and appear amplified against the late cycle narrative.
The surge in volatility has taken the level of the VIX above this year’s average of 15.1 but sharp spikes in volatility are not uncommon. Going back to 1990, the average level of the VIX index is 19.2, however, over the past five years the average has been 14.5. The more benign environment makes the breakouts in volatility seem more severe, but remain below historical averages. Moreover, periods of elevated volatility are becoming shorter. The market correction in February of this year was associated with a VIX above 35, higher than today’s figure, but returned to its long-term average nine days later. Market volatility has shown that it returns to more normal levels unless it is associated with an exceptional event. The current combination of market worries does not appear exceptional against the backdrop of still generally strong economic growth.
Investment implication
A busy political and corporate calendar over the coming weeks could keep markets on edge, but equity markets will eventually find their footing. Market corrections come part and parcel with investing, but without a high probability of a near-term recession, a bear market is unlikely. The third quarter of the U.S. earnings season will be crucial and could help anchor market sentiment. Even the possibility of lower earnings growth and higher rates could be offset by an adjustment in valuation multiples. This does not imply the end of the bull market run, but more moderate returns. The potential for strong returns in the final stages of the market cycle provide an incentive to remain invested. Over the course of the prior two cycles the S&P 500 has delivered in excess of 30% two years before the end, and 15% one year out.
Rather than recoiling from equity markets broadly, investors should consider the resiliency of their portfolio and whether they have the correct diversification-whether through diversified fixed income, alternative strategies, or simply more defensive income approaches-in place to protect against periods of higher volatility and market pull-backs. 

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter

Published by Ian Hui, Global Market Strategist, J.P.Morgan Asset Management

The Market Insights program provides comprehensive data and commentary on global markets without reference to products. Designed as a tool to help clients understand the markets and support investment decision-making, the program explores the implications of current economic data and changing market conditions.

For the purposes of MiFID II, the JPM Market Insights and Portfolio Insights programmes are marketing communications and are not in scope for any MiFID II / MiFIR requirements specifically related to investment research. Furthermore, the J.P. Morgan Asset Management Market Insights and Portfolio Insights programmes, as non-independent research, have not been prepared in accordance with legal requirements designed to promote the independence of investment research, nor are they subject to any prohibition on dealing ahead of the dissemination of investment research.

This document is a general communication being provided for informational purposes only. It is educational in nature and not designed to be taken as advice or a recommendation for any specific investment product, strategy, plan feature or other purpose in any  jurisdiction, nor is it a commitment from J.P. Morgan Asset Management or any of its subsidiaries to participate in any of the transactions mentioned herein. Any examples used are generic, hypothetical and for illustration purposes only. This material does not contain sufficient information to support an investment decision and it should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors should ensure that they obtain all available relevant information before making any investment. Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on certain assumptions and current market conditions and are subject to change without prior notice. All information presented herein is considered to be accurate at the time of production, but no warranty of accuracy is given and no liability in respect of any error or omission is accepted. It should be noted that investment involves risks, the value of investments and the income

from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yields are not a reliable indicator of current and future results.

J.P. Morgan Asset Management is the brand for the asset management business of JPMorgan Chase & Co. and its affiliates worldwide. This communication is issued by the following entities: in the United Kingdom by JPMorgan Asset Management (UK) Limited, which is authorized and regulated by the Financial Conduct Authority; in other European jurisdictions by JPMorgan Asset Management (Europe) S.à r.l.; in Hong Kong by JF Asset Management Limited, or JPMorgan Funds (Asia) Limited, or JPMorgan Asset Management Real Assets (Asia) Limited; in Singapore by JPMorgan Asset Management (Singapore) Limited (Co. Reg. No. 197601586K), or JPMorgan Asset Management Real Assets (Singapore) Pte Ltd

(Co. Reg. No. 201120355E); in Taiwan by JPMorgan Asset Management (Taiwan) Limited; in Japan by JPMorgan Asset Management (Japan) Limited which is a member of the Investment Trusts Association, Japan, the Japan Investment Advisers Association, Type II Financial Instruments Firms Association and the Japan Securities Dealers Association and is regulated by the Financial Services Agency (registration number “Kanto Local Finance Bureau (Financial Instruments Firm) No. 330”); in Korea by JPMorgan Asset Management (Korea) Company Limited; in Australia to wholesale clients only as defined in section 761A and 761G of the Corporations Act 2001 (Cth) by JPMorgan Asset Management (Australia) Limited (ABN 55143832080) (AFSL 376919); in Brazil by Banco J.P. Morgan S.A.; in Canada for institutional clients’ use only by JPMorgan Asset Management (Canada) Inc., and in the United States by JPMorgan Distribution Services Inc. and J.P. Morgan Institutional Investments, Inc., members of FINRA; and J.P. Morgan Investment Management Inc.

In APAC, distribution is for Hong Kong, Taiwan, Japan and Singapore. For all other countries in APAC, to intended recipients only.

Copyright 2018 JPMorgan Chase & Co. All rights reserved.

Material ID: 0903c02a823d663a