Global equities posted their first quarterly decline in two years during a volatile first quarter. Growing concerns about rising rates, trade wars and regulation in the technology sector will require a new mindset for investors.

The MSCI World Index fell by 2.3% in the first three months of the year in local-currency terms, with European and Japanese markets falling sharply (Display, left). US stocks were more resilient, but still ended the quarter down slightly. Yet the MSCI Emerging Markets Index advanced by 0.6%. Defensive stocks and resources led the declines (Display, middle), while cyclical stocks held up better. Growth stocks outperformed value stocks.

Volatility returned to the markets after several years of extraordinary calm, as we have anticipated in recent months. For example, the S&P 500 Index rose or fell by at least 1% in 23 trading sessions during the first three months of the year, compared to eight such sessions in all of 2017 (Display above, right). The renewed turbulence was triggered by a confluence of concerns that will require investors to apply new lenses when picking stocks for portfolios.

Rising Rates? Focus on Corporate Debt

Investors around the world have been fixated on the US Federal Reserve’s rate hikes. But this isn’t just an American story. Over time, we expect other countries to begin raising rates too. In other words, the virtuous cycle of global easing that we’ve become accustomed to in recent years could rapidly shift toward a vicious cycle of monetary policy tightening and rising rates, which will affect companies and stocks in many different ways.

Beneath the surface, there are already signs that stocks are becoming more sensitive to rising rates. Our research shows that companies with higher debt ratios underperformed significantly in the first quarter, while companies with lower leverage have outperformed in developed and emerging markets alike (Display, left). Similarly, US large-cap equity funds with relatively low debt/capital ratios have outperformed, while funds with the highest debt ratio have trailed their benchmark (Display, right).