▪ After six weeks of calm, equities dropped sharply on Friday in light of a spike in government bond yields and growing uncertainty over global monetary policy.
▪ We believe equity markets should be able to withstand rising yields and remain attractive compared to bonds. As such, we favor an overweight position in stocks.
U.S. equities were relatively quiet last week before falling sharply on Friday, as the S&P 500 Index declined 2.4% for the week.1 Global sovereign bond yields also spiked on Friday.1 Selloffs in both asset classes were triggered by rising uncertainty surrounding global monetary and fiscal policies. In other markets, oil prices rebounded from a two-week decline due to falling inventory levels.1
Near-Term Downside Pressure May Persist
Equity markets were remarkably stable for most of the summer before Friday’s sharp decline. The immediate cause appeared to be the European Central Bank’s decision not to expand its bond-buying program, and a growing sense that the Federal Reserve will raise rates this year. In our view, the selloff was magnified by high leverage on the part of many hedge funds and professional money managers. When volatility remains low, leverage tends to increase in the search for additional returns. Downside shocks can be exacerbated by these positions. Given that confusion and concern over central bank policies are likely to persist, and since there is probably more leverage that needs to unwind, we would not be surprised to see some additional near-term weakness in equity markets.